Optimal life-cycle portfolios for heterogeneous workers

Household portfolios include risky bonds, beyond stocks, and respondto permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investmentis constant or increasing in age before retirement for realisticparameter combinations. The driver of such inversion in the life-cycleprofile 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 labour income shocks and stock returns is matched by a realistically high variance of such shocks and/or risk aversion. Absent this combination,the typical downward sloping profile obtains. Overlooking differencesin optimal investment profiles across heterogeneous workers results inlarge 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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