A Multi-Objective Decision Framework for Lifecycle Investment

Abstract

In this paper we propose a multi-objective decision framework for lifecycle investment choice. Instead of optimizing individual strategies with respect to a single-valued objective, we suggest evaluation of classes of strategies in terms of the quality of the tradeoffs that they provide. The proposed framework takes inspiration from psychological theories which, on the one hand, assert that humans analyze risky choice situations in terms of several competing factors, and, on the other hand, recognize that attribute overload is detrimental to decision making. In particular, we use SP/A (security-potential/aspiration) theory as developed by Lopes and co-authors. The proposed approach is illustrated in a simple lifecycle model. As decision factors, we consider (a) the contribution paid, (b) the ambition level (targeted level of retirement income), and (c) the guarantee level (a level of retirement income that will be achieved with high probability). In terms of the tradeoffs generated between these indices, we compare a class of traditional lifecycle strategies, defined in terms of a glide path, with a class of so called collar strategies.

Keywords: Pension Plan Design, Choice Architecture, Lifecycle Investment, Dynamic Asset Allocation

JEL Classification: D81, G41, D15, H55