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The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective

Author

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  • Wade D. Pfau

    (National Graduate Institute for Policy Studies)

Abstract

Basu and Drew (in the JPM Spring 2009 issue) argue that lifecycle asset allocation strategies are counterproductive to the retirement savings goals of typical individual investors. Because of the portfolio size effect, most portfolio growth will occur in the years just before retirement when lifecycle funds have already switched to a more conservative asset allocation. In this article, we use the same methodology as Basu and Drew, but we do not share their conclusion that the portfolio size effect soundly overturns the justification for the lifecycle asset allocation strategy. While strategies that maintain a large allocation to stocks do provide many attractive features, we aim to demonstrate that a case for supporting a lifecycle strategy can still be made with modest assumptions for risk aversion and diminishing utility from wealth. Our differing conclusion results from four factors: (1) we compare the interactions between different strategies; (2) we consider a more realistic example for the lifecycle asset allocation strategy; (3) we examine the results for 17 countries; and (4) we provide an expected utility framework to compare different strategies. We find that with a very reasonable degree of risk aversion, investors have reason to prefer the lifecycle strategy in spite of the portfolio size effect.

Suggested Citation

  • Wade D. Pfau, 2010. "The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective," GRIPS Discussion Papers 10-11, National Graduate Institute for Policy Studies.
    • Handle: RePEc:ngi:dpaper:10-11
    as

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    File URL: https://grips.repo.nii.ac.jp/?action=repository_action_common_download&item_id=1032&item_no=1&attribute_id=20&file_no=1
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    References listed on IDEAS

    as
    1. Milevsky,Moshe A., 2006. "The Calculus of Retirement Income," Cambridge Books, Cambridge University Press, number 9780521842587, November.
    2. Mauricio Soto & Robert K. Triest & Alex Golub-Sass & Francesca Golub-Sass, 2008. "An Assessment of Life-Cycle Funds," Working Papers, Center for Retirement Research at Boston College wp2008-10, Center for Retirement Research, revised May 2008.
    3. Robert J. Shiller, 2005. "The Life-Cycle Personal Accounts Proposal for Social Security: A Review," NBER Working Papers 11300, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Retirement Planning and Worst-Case Scenarios
      by Wade Pfau in Pensions, Retirement Planning, and Economics Blog on 2011-07-02 19:45:00

    Citations

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    Cited by:

    1. Pfau, Wade Donald, 2011. "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle," MPRA Paper 28796, University Library of Munich, Germany.

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    More about this item

    Keywords

    lifecycle funds; target date funds; retirement planning; asset allocation; portfolio size effect;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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