How Sub-Optimal Are Age-Based Life-Cycle Investment Products?

22 Pages Posted: 10 Jul 2019 Last revised: 30 Jul 2019

See all articles by Gaurav Khemka

Gaurav Khemka

Australian National University (ANU)

Mogens Steffensen

University of Copenhagen

Geoff Warren

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Statistics

Date Written: July 29, 2019

Abstract

We investigate the conditions under which life-cycle investment strategies based on age may be ‘near enough’ to optimal, focusing on the treatment of the pension account balance and assumptions about risk aversion. We show that dynamically adjusting the strategy in response to fluctuations in the balance as well as age can lead to moderate improvements over product designs currently seen in the market; although most of the potential gains might be captured by specifying the glide path with reference to a measure of expected value of the balance over time. The risk aversion assumption emerges as a far more important consideration, with much greater utility losses arising from mismatches between the risk aversion of the investor and that underpinning the glide path design. Our analysis points towards possibilities for improving life-cycle or target date funds, and highlights the benefit of offering a suite of such funds that cater for members with differing risk aversion.

Keywords: life-cycle models, portfolio optimization, investment product design, target date funds

JEL Classification: C61, C63, G11, G23

Suggested Citation

Khemka, Gaurav and Steffensen, Mogens and Warren, Geoffrey J., How Sub-Optimal Are Age-Based Life-Cycle Investment Products? (July 29, 2019). Available at SSRN: https://ssrn.com/abstract=3416265 or http://dx.doi.org/10.2139/ssrn.3416265

Gaurav Khemka

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Mogens Steffensen

University of Copenhagen ( email )

Universitetsparken 5
DK-2100 Copenhagen
Denmark

Geoffrey J. Warren (Contact Author)

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Statistics ( email )

CBE Building 26C
Kingsley Sreet, Acton
Canberra, ACT 0200
Australia

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