Lifecycle Asset Allocation Strategies and the Distribution of 401(K) Retirement Wealth

41 Pages Posted: 17 Apr 2006 Last revised: 21 Sep 2010

See all articles by James M. Poterba

James M. Poterba

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Department of Economics

Joshua D. Rauh

Stanford Graduate School of Business; Hoover Institution; National Bureau of Economic Research (NBER)

David A. Wise

National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Steven F. Venti

Dartmouth College - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: January 2006

Abstract

This paper examines how different asset allocation strategies over the course of a worker's career affect the distribution of retirement wealth and the expected utility of wealth at retirement. It considers both rules that allocate a constant portfolio fraction to various assets at all ages, as well as "lifecycle" rules that vary the mix of portfolio assets as the worker ages. The analysis simulates retirement wealth using asset returns that are drawn from the historical return distribution. The results suggest that the distribution of retirement wealth associated with typical lifecycle investment strategies is similar to that from age-invariant asset allocation strategies that set the equity share of the portfolio equal to the average equity share in the lifecycle strategies. There is substantial variation across workers with different characteristics in the expected utility from following different asset allocation strategies. The expected utility associated with different 401(k) asset allocation strategies, and the ranking of these strategies, is very sensitive to three parameters: the expected return on corporate stock, the worker's relative risk aversion, and the amount of non-401(k) wealth that the worker will have available at retirement. At modest levels of risk aversion, or in the presence of substantial non-401(k) wealth at retirement, the historical pattern of stock and bond returns implies that the expected utility of an all-stock investment allocation rule is greater than that from any of the more conservative strategies. Higher risk aversion or lower expected returns on stocks raise the expected utility of following lifecycle strategies or other strategies that reduce equity exposure throughout the lifetime.

Suggested Citation

Poterba, James M. and Rauh, Joshua D. and Wise, David A. and Venti, Steven F., Lifecycle Asset Allocation Strategies and the Distribution of 401(K) Retirement Wealth (January 2006). NBER Working Paper No. w11974. Available at SSRN: https://ssrn.com/abstract=878061

James M. Poterba (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Joshua D. Rauh

Stanford Graduate School of Business ( email )

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Hoover Institution ( email )

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National Bureau of Economic Research (NBER)

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David A. Wise

National Bureau of Economic Research (NBER) ( email )

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Harvard University - Harvard Kennedy School (HKS)

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Steven F. Venti

Dartmouth College - Department of Economics ( email )

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603-646-2122 (Fax)

National Bureau of Economic Research (NBER)

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United States

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