Eggs and Baskets: Lifecycle Portfolio Dynamics

Abstract

How do people save and allocate their asset portfolio over the lifetime? To answer this question, we build and estimate a dynamic lifecycle model of saving and portfolio choice. Besides safe and risky financial assets inside and outside pension plans with rich choice architecture, we also include risky labor income and housing. Using this model, we examine the behavior of members of an industry-wide retirement fund to assess how standard saving motives, pension defaults, investment returns, preferences, and frictions interact to drive lifetime savings patterns across major asset classes. Our results show considerable heterogeneity in motivations to save. First, we find that consumption smoothing is the main driver of financial and housing asset accumulation. For pension wealth, its role is mitigated by default switching costs, with costless switching encouraging pension savings at the expense of financial wealth, but not housing. In fact, we find higher pension assets drive up housing throughout the lifecycle, as people - anticipating wealthier retirement and to avoid potentially larger housing adjustment costs later on - lock in higher housing investments early. Second, we allow participants to treat bequests as luxury goods. This motivates higher defined contribution take-up and riskier portfolios but only modest boosts to mid-life financial savings. Third, savings made as a precaution against earnings risks have similar effects to bequests on pension assets, although they do not translate into wealth dynamics. Fourth, if people cannot borrow against home equity using mortgage redraws they will hold higher financial savings. This will ultimately come at the expense of pension balances more than housing wealth.

Keywords: lifetime savings, portfolio choice, income risk, defaults, method of moments

JEL Classification: H8, J26, J32