Managing Retirement Savings: Objectives and Risk

Abstract

Retirement is not the only motivation of saving but it is a prominent one. Whether channelled through pension funds or individual accounts, the question of how to allocate retirement savings, and in particular which degree of risk to tolerate, is fundamental. Investing in risky assets should not be viewed as a way to compensate for insufficient savings during a life time, or a way to optimise the likelihood of reaching a future consumption target, whatever the consequences in bad circumstances. However, as risk free assets tend to vanish, or yield negative returns, investing in risky assets are a way to improve expected returns on savings, and thus expected purchasing power at old age, provided the cost of risk may be mitigated. One way of increasing the tolerance to investment risk is the potential stream of future labour income if there is some flexibility on the retirement departure age or the possibility having a job (full or part-time) during the first years of retirement. With reasonable parameters, such flexibility provides a significant incentive to increase investment in risky assets and provide significant welfare gains. Finally, flexibility is a cause for the optimal share of risky assets to decline with age.