Optimal life-cycle portfolios for heterogeneous workers

Household portfolios include risky bonds, beyond stocks, and respond to permanent labor income shocks. This article brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor’s risk appetite. This occurs if a small positive contemporaneous correlation between permanent labor income shocks and stock returns is matched by a realistically high degree of risk aversion. Absent this combination, the typical downward-sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15–30% of lifetime consumption.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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