Targeting Retirement Security with a Dynamic Asset Allocation Strategy

Abstract

The goal of investing for retirement is to secure a target level of income that maintains the individual’s preretirement lifestyle. Current “safe harbor” glide-path products shift investments from stocks to bonds on the basis of the individual’s age. This approach is unlikely to secure a target retirement income because the glide path is focused on the wrong goal. We tested a dynamic asset allocation strategy that takes no view of future market performance and is based on a retirement income goal. We show how this dynamic strategy could dominate standard portfolio choices. The article introduces a new way to think about intermediate retirement targets and explores the implications of the dynamic asset allocation strategy for the level of savings required to achieve a retirement goal.

Disclosure: The authors report no conflicts of interest.

Editor’s Note

This article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the author thanked the reviewers in the acknowledgments. Christina Atanasova, Michael Drew, and one anonymous reviewer were the reviewers for this article.

Submitted 1 October 2019

Accepted 14 April 2020 by Stephen J. Brown.

Acknowledgments

The authors thank Robert C. Merton, Kazuhiko Ohashi, and Sunghwan Shin for their collaborations on SeLFIES. In addition, Daniel Mantilla-Garcia, Eric Hovey, and the Financial Analysts Journal editors and reviewers provided useful feedback and comments that greatly improved the article.

Notes

¹ The proposed dynamic asset allocation strategy is not totally divorced from so-called dynamic portfolio insurance strategies. A GLIDeS approach lowers risk once the retirement goal has been achieved, and the rebalancing is not simply driven by short-term changes in the equity market (i.e., buying in up markets and selling in down markets). That said, a similarity is that GLIDeS potentially benefits from higher volatility, thus exhibiting some kind of optionality, as shown in the high-inflation and Japan scenarios to come (where the central expectations for asset returns are gloomy). GLIDeS has similarities to a more complex approach that would use an “options-replication” strategy to minimize the downside while attempting to achieve the goal. In the options approach, the delta of the option specifies the dynamic allocations to the risky and safe assets.

² Note that if the Z parameter equals 0.5, then the allocation scheme takes its inflection at AFS = 50%.