Portfolio choice after retirement: Should self-annuitisation strategies hold more equities?

Abstract

We compare the performance of alternative investment strategies in the decumulation phase for retirees who self-annuitise. We find that portfolios with constant high exposure to equities, as well as portfolios that increase exposures to equities over time, consistently outperform conservative portfolios which avoid investment in equities or the conventional lifecycle portfolios which reduce allocation to equities over time. While an increasing equity glidepath improves the performance of an investment strategy, the allocations to equities at the start of retirement is critical. Using a ‘utility of terminal wealth’ approach that allows for loss aversion as in prospect theory of Kahneman and Tversky (1979), we find a growth portfolio with very high (but not total) exposure to equities to dominate the alternative strategies at low and moderate thresholds. With further increases in wealth threshold levels, a strategy with an all equity allocation becomes dominant. The lifecycle portfolio is dominated by the ‘reverse lifecycle’ portfolio at all threshold levels. Finally, for retirees who defer annuitisation, we find strategies with a higher equity component have greater likelihood of outperforming an immediate annuitisation strategy in terms of generating a guaranteed income late in retirement.