Evaluating Retirement Strategies: A Utility-Based Approach

Abstract

Retirees need to make two critical financial decisions, namely, the withdrawal rate and the asset allocation of their portfolios. We propose a methodology that retirees, and particularly advisors, could use to make these decisions in an optimal way. We introduce a new variable, the coverage ratio, and a theoretical approach, based on utility. Our approach can be used to make optimal decisions during both the accumulation and the retirement period, but we illustrate it by focusing on the latter, and particularly on the choice of an optimal asset allocation. We find that the strategies selected by our utility-based approach are in general somewhat more aggressive than those selected by the failure rate and other existing approaches.

Keywords: Retirement Strategies; Failure Rate; Coverage Ratio; Utility-Based Analysis

JEL Classification: G11