Toward Determining the Optimal Investment Strategy for Retirement
11 Pages Posted: 3 Jan 2019
Date Written: December 14, 2018
Investors who are about to retire are first and foremost concerned with supporting their spending needs throughout retirement. But they also derive satisfaction from growing their wealth beyond what is needed to support consumption in order to leave a bequest to their heirs or chosen charities. The predominant metric for evaluating retirement investment strategies is the failure rate. However, it fails to distinguish between strategies that fail early in retirement from those that fail near the end of retirement. Moreover, it fails to account for potential bequests. To overcome these shortcomings we propose a new metric, the coverage ratio, which is more comprehensive and informative than the failure rate. In addition, we propose a utility function to evaluate the coverage ratio, which penalizes shortfalls more than it rewards surpluses. Finally, we use the framework we propose to determine the optimal allocation to stocks and bonds using both historical and simulated returns.
Keywords: retirement strategies; failure rate; coverage ratio; asset allocation
JEL Classification: G11
Suggested Citation: Suggested Citation