Sustainable Asset Allocation in Retirement:

Stochastic Optimization in a Downside Risk Framework


W. V. Harlow

Keith C. Brown



November 2011





Once an individual has retired, asset allocation becomes a critical investment decision. Unfortunately, there is no consensus on what the optimal allocation should be for retirees of varying age, gender and risk tolerance. This study analyzes the allocation question through a focus on the downside risks created by uncertainty over investment returns and life expectancy. We find that the range of appropriate equity asset allocations in retirement is strikingly low compared to typical lifecycle and retirement funds now in the marketplace. In fact, for retirement portfolios whose primary goal is to minimize the risk of depletion and sustain withdrawals, optimal equity allocations range between 5 and 25 percent. This quite conservative level of equity holdings changes little even when we significantly change our assumptions on capital market returns. We even find that more aggressive equity allocations, those that still retain some focus on depletion risk but also seek to provide substantial bequests to heirs, are also relatively conservative in their stock allocations. We conclude that the higher equity allocations commonly used in retirement investment products significantly underestimate the risks that these higher-volatility portfolios pose to the sustainability of retirees’ savings and incomes.


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