Optimal and Simple, Nearly Optimal Rules for Minimizing the Probability Of Financial Ruin in Retirement

Abstract

The increasing risk of poverty in retirement has been well documented; it is projected that current and future retirees’ living expenses will significantly exceed their savings and income. In this paper, we consider a retiree who does not have sufficient wealth and income to fund her future expenses, and we seek the asset allocation that minimizes the probability of financial ruin during her lifetime. Building on the work of Young (2004) and Milevsky, Moore, and Young (2006), under general mortality assumptions, we derive a variational inequality that governs the ruin probability and optimal asset allocation. We explore the qualitative properties of the ruin robability and optimal strategy, present a numerical method for their estimation, and examine their sensitivity to changes in model parameters for specific examples. We then present an easy-to-implement allocation rule and demonstrate via simulation that it yields nearly optimal ruin probability, even under discrete portfolio rebalancing.