Market Risk, Mortality Risk, and Sustainable Retirement Asset Allocation: A Downside Risk Perspective


W. V. Harlow

Keith C. Brown



December 2014





Despite its clear importance to retirement investing, there is no consensus on what the optimal asset 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 the joint uncertainty over investment returns and life expectancy. Using a new analytical approach, we show that focusing on the severity of retirement funding shortfalls (downside risk), rather than just the probability of ruin, increases the sustainability of a retirement portfolio.  We demonstrate that the range of appropriate equity allocations is strikingly low compared to typical life-cycle and retirement funds now in existence. For retirement portfolios with the primary goal to minimize downside risk and sustain withdrawals, optimal equity allocations range between 5 and 25 percent and vary little with alternative assumptions on capital market conditions. We also show that more aggressive investors—those that focus on downside risk but seek to provide substantial bequests to heirs—should still be relatively conservative in their stock allocations. We conclude that the higher equity allocations commonly employed in practice significantly underestimate the risks that these higher-volatility portfolios pose to the sustainability of retirees’ savings and incomes.


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