How Important Is Asset Allocation To Financial Security In Retirement?
The motivation for this paper is the concern that financial advice – the topic of this conference – tends to focus on financial assets, applying tools that give prominence to the asset allocation decision. But most people have little financial wealth, and financial tools are often silent on the levers that will have a much larger effect on retirement security for the majority of Americans. These levers include delaying retirement, tapping housing equity through a reverse mortgage, and controlling spending. Moreover, even for many with substantial assets, these non-financial levers may be as powerful as asset allocation in attaining retirement security.
This paper proceeds in three stages. The first section reports a simple Excel spreadsheet exercise that provides a stylized example of the tradeoff between returns and time spent in the labor force.
The second section uses data from the Health and Retirement Study (HRS) on pre-retirees aged 51-64 to see how the gap between retirement needs and retirement resources is affected by working longer, taking out a reverse mortgage, controlling spending, and shifting all assets to equities with no risk. The third section uses a simple dynamic programming model to calculate a risk-adjusted measure of the value for the average household of moving from a typical conservative portfolio to an optimal portfolio.
The answer from all three exercises is the same. The focus on asset allocation is misplaced. Households have much more potent levers for achieving retirement security.