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Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation

Author

Listed:
  • Fabio C. Bagliano

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

  • Carolina Fugazza

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

  • Giovanna Nicodano

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

Abstract
How should workers invest over the life-cycle? Should they follow some typical prescriptions ("rules of thumb") in personal finance implying higher equity investments when young? We show that the answer hinges on the risk of long-term unemployment spells, entailing permanent declines in workers' future earnings prospects. Absent unemployment risk, extant prescriptions deliver portfolios that are close to optimal, implying negligible welfare losses. They instead lead to sizable welfare losses (3-9% of annual consumption) when the risk of human capital depreciation following long-term unemployment is considered and realistically calibrated to the U.S. labor market. These losses stem from excess risk taking when young investors face uncertainty about future labor and pension incomes. This result points to a new design for pension plans offered by long-term institutional investors.

Suggested Citation

  • Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2020. "Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation," Working papers 068, Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.
    • Handle: RePEc:tur:wpapnw:068
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    welfare; life-cycle portfolio choice; unemployment risk; long term unemployment; age rules.;
    All these keywords.

    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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