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The cost of diversification over time, and a simple way to improve target-date funds

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  • Levy, Haim
  • Levy, Moshe

Abstract

Diversification across time means changing the asset allocation over time. We show that under mild conditions diversification across time is inferior for all risk-averters and for all investment horizons, relative to a portfolio with the same average asset allocation, held constant over time. Target-date funds help reduce the variation in the asset allocation throughout the lifecycle, by implicitly considering the reduction in human capital with age. However, their structure implies two systematic deviations from constant asset allocation. We suggest a simple correction leading to a typical increase of 5%-22% in welfare.

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  • Levy, Haim & Levy, Moshe, 2021. "The cost of diversification over time, and a simple way to improve target-date funds," Journal of Banking & Finance, Elsevier, vol. 122(C).
    • Handle: RePEc:eee:jbfina:v:122:y:2021:i:c:s0378426620302570
    DOI: 10.1016/j.jbankfin.2020.105995
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    4. Mantilla-Garcia, Daniel & Martellini, Lionel & Garcia-Huitrón, Manuel E. & Martinez-Carrasco, Miguel A., 2024. "Back to the funding ratio! Addressing the duration puzzle and retirement income risk of defined contribution pension plans," Journal of Banking & Finance, Elsevier, vol. 159(C).
    5. Azra Zaimovic & Adna Omanovic & Almira Arnaut-Berilo, 2021. "How Many Stocks Are Sufficient for Equity Portfolio Diversification? A Review of the Literature," JRFM, MDPI, vol. 14(11), pages 1-30, November.

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    More about this item

    Keywords

    Diversification across time; Diversification throughout time; Lifecycle investing; Target-date fund; Glide-path; Stochastic dominance; Market timing; Return chasing;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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