Deferred Annuities and Strategic Asset Allocation

We derive the optimal portfolio choice and consumption pattern over the lifecycle for households facing labor income, capital market, and mortality risk. In addition to stocks and bonds, households also have access to deferred annuities. Deferred annuities offer a hedge against mortality risk and provide similar benefits as Social Security. We show that a considerable fraction of wealth should be annuitized to skim the return enhancing mortality credit. The remaining liquid wealth (stocks and bonds) is used to hedge labor income risk during work life and to earn the equity premium. We find a marginal difference between a strategy involving deferred annuities and one where the investor can purchase immediate life annuities.

Time is money: life cycle rational inertia and delegation of investment management : [Version November 2013]

We investigate the theoretical impact of including two empirically-grounded insights in a dynamic life cycle portfolio choice model. The first is to recognize that, when managing their own financial wealth, investors incur opportunity costs in terms of current and future human capital accumulation, particularly if human capital is acquired via learning by doing. The second is that we incorporate age-varying efficiency patterns in financial decisionmaking. Both enhancements produce inactivity in portfolio adjustment patterns consistent with empirical evidence. We also analyze individuals’ optimal choice between self-managing their wealth versus delegating the task to a financial advisor. Delegation proves most valuable to the young and the old. Our calibrated model quantifies welfare gains from including investment time and money costs, as well as delegation, in a life cycle setting

Money in Motion: Dynamic Portfolio Choice in Retirement

Retirees confront the difficult problem of how to manage their money in retirement so as to not outlive their funds while continuing to invest in capital markets. We posit a dynamic utility maximizer who makes both asset location and allocation decisions when managing her retirement financial wealth and annuities, and we prove that she can benefit from both the equity premium and longevity insurance in her retirement portfolio. Even without bequests, she will not fully annuitize; rather, her optimal stock allocation amounts initially to more than half of her financial wealth and declines with age. Welfare gains from this strategy can amount to 40 percent of financial wealth (depending on risk parameters and other resources). In practice, it turns out that many retirees will do almost as well by purchasing a variable annuity invested 60/40 in stocks/bonds.

Optimal Life-Cycle Strategies in the Presence of Interest Rate and Inflation Risk

Defined Contribution Plan

Cognitive Ability, Financial Literacy, and the Demand for Financial Advice at Older Ages: Findings from the Health and Retirement Study

This paper evaluates how cognitive ability and financial literacy shape the demand for financial advice at older ages. We analyze a new module of the Health and Retirement Study which queried older respondents about their usage of financial advice and other financial management activities. Results show that cognitive ability and financial literacy are often positively correlated with advice-seeking for financial matters. Generally speaking, the more cognitively able tend to seek financial advice from professionals outside of family members; nevertheless, they are also more likely to be overconfident regarding their investments. The more financially literate also tend to ask for help with money management, but they are less likely to be overconfident. Overall, our findings are suggestive that cognitive ability as well as financial literacy can help shape older persons’ money management behaviors

Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts

This paper shows how lifelong survival-contingent payouts can enhance investor wellbeing in the context of a portfolio choice model which integrates uninsurable labor income and asymmetric mortality expectations. Our model generates optimal asset location patterns indicating how much to hold in liquid versus illiquid survival-contingent payouts over the lifetime, and also asset allocation paths, showing how to invest in stocks versus bonds. We conrm that the investor will gradually move money out of her liquid saving into survivalcontingent assets to retirement and beyond, thereby enhancing her welfare by as much as 50 percent. The results are also robust to the introduction of uninsurable consumption shocks in housing expenses, income flows during the worklife and retirement, sudden changes in health status, and medical expenses.

Lifecycle Impacts of the Financial and Economic Crisis on Household Optimal Consumption, Portfolio Choice, and Labor Supply

The direct financial impact of the financial crisis has been to deal a heavy blow to investment-based pensions; many workers lost a substantial portion of their retirement saving. The financial sector implosion in turn produced an economic crisis for the rest of the economy via high unemployment and reduced labor earnings, which reduced contributions to Social Security and private pensions. Our research asks which types of individuals were most affected by these dual financial and economic shocks, and it also explores how people may react by changing their consumption, saving and investment, work and retirement, and annuitization decisions. We do so with a realistically calibrated lifecycle framework allowing for time-varying investment opportunities and countercyclical risky labor income dynamics. We show that households near retirement will reduce both short- and long-term consumption, boost work effort, and defer retirement. Younger cohorts will initially reduce their work hours, consumption, saving, and equity exposure; later in life, they will have to work more, retire later, consume less, invest more in stocks, and save more.Social Security Administrationhttp://deepblue.lib.umich.edu/bitstream/2027.42/87952/1/wp246.pd

Deferred Annuities and Strategic Asset Allocation

We derive the optimal portfolio choice and consumption pattern over the lifecycle for households facing labor income, capital market, and mortality risk. In addition to stocks and bonds, households also have access to deferred annuities. Deferred annuities offer a hedge against mortality risk and provide similar benefits as Social Security. We show that a considerable fraction of wealth should be annuitized to skim the return enhancing mortality credit. The remaining liquid wealth (stocks and bonds) is used to hedge labor income risk during work life and to earn the equity premium. We find a marginal difference between a strategy involving deferred annuities and one where the investor can purchase immediate life annuities.Social Security Administrationhttp://deepblue.lib.umich.edu/bitstream/2027.42/61804/1/wp178.pd

Mortality Contingent Claims: Impact of Capital Market, Income, and Interest Rate Risk

In this paper, we consider optimal insurance, portfolio allocation, and consumption rules for a stochastic wage earner with CRRA preferences whose lifetime is random. In a continuous time framework, the investor has to decide among short and long positions in mortality contingent claims a.k.a. life insurance, stocks, bonds, and money market investment when facing a risky stock market and interest rate risk. We find an analytical solution for the complete market case in which human capital is exactly priced. We also extend the analysis to the case where income is unspanned. An illustrative analysis shows when the wage earner’s demand for life insurance switches to the demand for annuities.Social Security Administrationhttp://deepblue.lib.umich.edu/bitstream/2027.42/64478/1/wp222.pd

Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts

This paper shows how lifelong survival-contingent payouts can enhance investor wellbeing in the context of a portfolio choice model which integrates uninsurable labor income and asymmetric mortality expectations. Our model generates optimal asset location patterns indicating how much to hold in liquid versus illiquid survival-contingent payouts over the lifetime, and also asset allocation paths, showing how to invest in stocks versus bonds. We confirm that the investor will gradually move money out of her liquid saving into survival-contingent assets to retirement and beyond, thereby enhancing her welfare by as much as 50 percent. The results are also robust to the introduction of uninsurable consumption shocks in housing expenses, income flows during the worklife and retirement, sudden changes in health status, and medical expenses.