Portfolio Decisions of Older American Workers: The Role of Private Pensions

Abstract

With a large proportion of the USA population getting closer to retirement age, it is necessary to ensure the security of the retirement wealth for this old generation. In order to do so, it is important to understand not only how much wealth older workers hold, but also how they hold it. This research is one of the first studies to investigate the effect of pension type on older workers' asset allocation decisions. After the pension type transition, from Defined Benefit (DB) to Defined Contribution (DC) plans, stock market risk has been transferred from firms to individuals, in the sense that older workers with DC pensions are more exposed to the risk in the financial market return rate. Since the beginning of 2000, the US stock market has sharply declined, which has directly influenced the value of retirement assets, namely the value of DC pension plans, given many DC pension accounts were invested in the financial market. As a result, this stock market failure might then cause unexpected insufficiency in the retirement wealth for those with DC pensions. My hypothesis is that people with different types of pensions will allocate their non-pension wealth differently according to their pension type. Specifically, older workers with DC pensions might have already adjusted their asset allocation in such a way that they will have enough to maintain their standard of living, even when the market return is low and their pension values are reduced. In this study, I first present a theoretical model in a dynamic setting, in which the asset allocation decisions are endogenously determined. Then, I use the data from all available waves of the Health and Retirement Study (HRS), a panel survey of retirement age respondents and their spouses, from 1992 to the present, to perform the empirical analysis. The empirical work studies the effect of pension type on asset allocation by comparing the non-pension wealth portfolio choices of older workers with DB pensions and of those with DC pensions. Preliminary results show that pension type does have an effect on people's asset allocation decisions, which might be informative to policy makers in the debate on Social Security privatization.