Wealth Outcomes Research Articles

Financial Literacy, Schooling, and Wealth Accumulation

Financial literacy and schooling attainment have been linked to household wealth accumulation. Yet prior findings may be biased due to noisy measures of financial literacy and schooling, as well as unobserved factors such as ability, intelligence, and motivation that could enhance financial literacy and schooling but also directly affect wealth accumulation. We use a new household dataset and an instrumental variables approach to isolate the causal effects of financial literacy and schooling on wealth accumulation. While financial literacy and schooling attainment are both strongly positively associated with wealth outcomes in linear regression models, our approach reveals even stronger and larger effects of financial literacy on wealth. Estimated impacts are substantial enough to suggest that investments in financial literacy could have large positive effects on household wealth accumulation.

Have changing takeover defense rules and strategies entrenched management and damaged shareholders? The case of defeated takeover bids

Using the Delaware Supreme Court's Time-Warner decision of July 1989 as a focal point, we study defeated takeover bids before and after July 1989 to assess the direct effects of stronger takeover impediments on takeover defense tactics used to defeat bids and the resulting shareholder wealth outcomes and managerial turnover. We find that firms that defeated takeover bids after July 1989 shifted away from the use of active takeover defenses (repurchases, special dividends, greenmail, and leverage increases). Nevertheless, shareholders of firms that defeat a takeover experienced slightly better wealth outcomes in the 1990s than in the 1980s. We also find increased managerial turnover rates after defeating a takeover bid post Time-Warner, suggesting that managers that defeat hostile takeover bids did not become more entrenched due to greater takeover impediments relative to prior years.

Income, Assets, and Poverty: Older Women in Comparative Perspective

We analyze the economic well‐being of older women in cross‐national perspective, comparing the United States with four other high‐income countries: the United Kingdom, Germany, Italy, and Sweden. We report some of the first findings based on microdata from a new source, the Luxembourg Wealth Study (LWS). The LWS, a project within the larger Luxembourg Income Study (LIS), is a database containing harmonized wealth datasets from a number of industrialized countries. Using the LWS data, we analyze the income and wealth packages held by women, aged 60 and older, across these five countries. We begin by assessing employment, income, and wealth outcomes, first among all older women's households and, second, in one particularly vulnerable group: older women who live alone. We then turn our attention to poor older women and, finally, to those who are extremely poor. We close with brief comments about policy implications and further research.

Portfolio Size Effect in Retirement Accounts: What Does It Imply for Lifecycle Asset Allocation Funds?

Lifecycle funds offered by retirement plan providers allocate aggressively to risky asset classes when the employee participants are young, gradually switching to more conservative asset classes as they grow older and approach retirement. This approach focuses on maximizing growth of the accumulation fund in the initial years and preserving its value in the later years. The authors simulate terminal wealth outcomes based on conventional lifecycle asset allocation rules as well as on contrarian strategies that reverse the direction of asset switching. The evidence suggests that the growth in portfolio size over time significantly impacts the asset allocation decision. Due to the portfolio size effect that is observed by the authors, the terminal value of accumulation in retirement accounts is influenced more by the asset allocation strategy adopted in later years relative to that adopted in early years. By mechanistically switching to conservative assets in the later years of a plan, lifecycle strategies sacrifice significant growth opportunity and prove counterproductive to the participant9s wealth accumulation objective. The authors9 conclude that this sacrifice does not seem to be compensated adequately in terms of reducing the risk of potentially adverse outcomes. <b>TOPICS:</b>Retirement, fixed-income portfolio management, in wealth management

Dynamic Lifecycle Strategies for Target Date Retirement Funds

Lifecycle funds offered to retirement plan participants gradually reduce their exposure to stocks as they approach the target date of retirement. We show that such deterministic switching rules produce inferior wealth outcomes for the investor compared to strategies that dynamically alter the allocation between growth and conservative assets based on cumulative portfolio performance relative to a set target. The dynamic allocation strategies proposed in this paper exhibit almost stochastic dominance (ASD) over strategies that switch assets unidirectionally without consideration of portfolio performance.

How Many Mutual Funds Are Needed to Form a Well- Diversified Asset Allocated Portfolio?

Funds of funds, which have become a popular investment vehicle in recent years, diversify across asset classes as well as managers with different styles and expertise. Lifecycle funds are a good example of funds of funds where investors can invest in a group of asset classes in different proportions depending on their investment horizon, risk tolerance, and objectives. Given that the number of mutual funds in the portfolios of lifecycle funds offered by different investment companies varies significantly even for those with similar targets, it is important to investigate the relationship between the number of mutual funds in an asset allocated portfolio and the resulting diversification benefits. As investors in lifecycle funds are concerned with the level of wealth they will have accumulated as of a target date, the variability of terminal wealth at the end of a given holding period is a relevant measure of risk for their portfolios. In this article the authors use a survivorship-bias-free sample to assess the impact of the number of mutual funds in an asset allocated portfolio on the variability and shortfall risk of its terminal wealth. Specifically, they run simulations to generate a large number of terminal wealth level outcomes for a portfolio with a given number of funds. Then, they obtain the frequency distribution of the terminal wealth outcomes, and use its dispersion as the risk measure in the analysis. The findings for three asset allocation scenarios, which are reported for 5-year and 10-year investment horizons, indicate that holding 10 to 12 funds in the portfolio instead of the minimum possible 2 funds as dictated by the asset allocation to equity and bonds reduces the standard deviation of terminal wealth by about 60%. This reduction can be obtained without sacrificing expected terminal wealth levels, and hence without a reduction in total returns. Similarly, the mean shortfall of terminal wealth and the semivariance of terminal wealth are reduced by 60% and 85%, respectively. <b>TOPICS:</b>Portfolio construction, long-term/retirement investing, wealth management

Defined contribution plans, defined benefit plans, and the accumulation of retirement wealth

The private pension structure in the United States, once dominated by defined benefit (DB) plans, is currently divided between defined contribution (DC) and DB plans. Wealth accumulation in DC plans depends on a participant's contribution behavior and on financial market returns, while accumulation in DB plans is sensitive to a participant's labor market experience and to plan parameters. This paper simulates the distribution of retirement wealth under representative DB and DC plans. It uses data from the Health and Retirement Study (HRS) to explore how asset returns, earnings histories, and retirement plan characteristics contribute to the variation in retirement wealth outcomes. We simulate DC plan accumulation by randomly assigning individuals a share of wages that they and their employer contribute to the plan. We consider several possible asset allocation strategies, with asset returns drawn from the historical return distribution. Our DB plan simulations draw earnings histories from the HRS, and randomly assign each individual a pension plan drawn from a sample of large private and public defined benefit plans. The simulations yield distributions of both DC and DB wealth at retirement. Average retirement wealth accruals under current DC plans exceed average accruals under private sector DB plans, although DC plans are also more likely to generate very low retirement wealth outcomes. The comparison of current DC plans with more generous public sector DB plans is less definitive, because public sector DB plans are more generous on average than their private sector DB counterparts.

An integral index for measuring aversion to large‐scale risks

PurposeConventional measures of risk aversion based on first and second derivatives of utility are strictly local instruments, valid only for infinitesimally small changes in wealth. This paper to develop a global index suitable for assessing attitudes toward large‐scale risks.Design/methodology/approachIntegral calculus is used to measure the geometric area between an individual's actual utility function and a linear function displaying risk neutrality, over the entire range of potential wealth outcomes for a given risk. The area is then converted to an index number.FindingsLocal and global measures of risk aversion yield similar interpersonal comparisons only for small risks; with larger risks, local measures distort interpersonal differences. The analysis also shows that individuals having exponential utility functions evaluate risk exclusively on the basis of wealth dispersion, whereas those with logarithmic or square‐root utilities consider both the mean and variance of wealth.Research/limitations/implicationsThe global index is quantifiable if the functional form of utility is known; further research is needed to approximate the index when information about utility is limited.Practical implicationsThe most important risks encountered in practice, such as the possibility of unemployment or disability, involve variations in wealth far larger than differential calculus is designed to accommodate. The integral index therefore provides a more appropriate basis for measuring and comparing risk preferences.Originality/valueThe paper provides an innovative geometric interpretation of global risk aversion, and in contrast to local measures, the integral index captures differences in the intensity of an individual's aversion toward risks of various magnitudes.

Item non-response on income and wealth questions

This study investigates the mechanisms determining item nonresponse focusing on three issues: First, is there significant heterogeneity in item non-response across financial questions and in the association of covariates with item non-response across outcomes? Second, can the informational value of surveys be improved by matching interviewers and respondents based on their characteristics? Third, how does offering a “don’t know” answer option affect respondent behavior? The questions are answered based on detailed survey and interviewer data from the German Socioeconomic Panel using a broad set of income and wealth outcomes. We find considerable heterogeneity in non-response across financial items, little explanatory power of interviewer-respondent matches and strong evidence that ‘‘don’t know’’ answers result from mechanisms that differ from those yielding valid responses and outright refusals to respond.

Lifetime Earnings Variability and Retirement Wealth

This paper explores how earnings variability is related to retirement wealth. Past research has demonstrated that the average American household on the verge of retirement would need to save substantially more, in order to preserve consumption flows in old age. While several socioeconomic factors have been examined that might explain such problems, prior studies have not assessed the role of earnings variability over the lifetime as a potential explanation for poor retirement prospects. Thus two workers having identical levels of average lifetime earnings might have had very different patterns of earnings variability over their lifetimes. Such differences could translate into quite different retirement wealth outcomes. This paper evaluates the effect of earnings variability on retirement wealth using information supplied by respondents to the Health and Retirement Study (HRS). This is a rich and nationally representative dataset on Americans on the verge of retirement, with responses linked to administrative records from the Social Security Administration. Our research illuminates the key links between lifetime earnings variability and retirement wealth.

Does Marital History Matter? Marital Status and Wealth Outcomes Among Preretirement Adults

Data from the 1992 Health and Retirement Survey are used to specify ordinary least squares (OLS) regression models predicting wealth. Separate models are estimated for men and women. The results indicate that individuals who are not continuously married have significantly lower wealth than those who remain married throughout the life course. Remarriage offsets the negative effect of a marital dissolution. There are significant gender differences in these effects. The results demonstrate that accounting for the sequence of marital events provides a detailed picture of the life paths that lead to wealth heterogeneity among the older population.

Item Non-Response on Income and Wealth Questions

After reviewing the literature on item non-response we focus on three issues: First, is there significant heterogeneity in item non-response across financial questions and in the association of covariates with item non-response across outcomes? Second, can the informational value of surveys be improved by matching interviewers and respondents based on their characteristics? Third, how does offering a don't know answer option affect respondent behavior? The questions are answered based on detailed survey and interviewer data from the German Socioeconomic Panel, considering a broad set of income and wealth outcomes.

Discontinuities in the Distribution of Great Wealth: Sectoral Forces Old and New

National surveys of household economics and well-being in the United States usually focus on income. In those income surveys with supplemental wealth modules, the very rich are underrepresented if not unrepresented. Typically, wealth data are truncated such that they do not afford a view of the extreme top of the distribution. Therefore, we attempt to supplement our knowledge about elite wealth holdings by compiling data on the richest individuals and families in the United States. To do so, we draw from the rosters of the Four Hundred, which have been published annually by Forbes magazine since 1982. Along with information from other business press reports and standard biographical sources, rosters of the very rich enable research on inequality at the extreme of the wealth distribution during a period of dramatic change in the composition and concentration of wealth. In this study, we focus analytically on economic sectors because we are interested less in the maldistribution of wealth by demographic groups than in inequality between different economic sectors. We will first specify our analytical approach, then examine issues in the use of business press rosters of the very rich as a data source, and follow with a discussion of the dimensions and categories of our sector typology. After presenting our results, we will address how sectoral forces old and new affect economic opportunity and great wealth outcomes.

Family Structure, Race, and Wealth Ownership: A Longitudinal Exploration of Wealth Accumulation Processes

Researchers have documented racial inequalities in wealth ownership and have offered a variety of explanations to account for these differences. One potentially important contributing factor that has received little attention is racial differences in family structure. This paper explores racial differences in the structure of family of origin and family in adulthood and examines the impact of these differences on wealth accumulation patterns. Using the National Longitudinal Survey of Youth, I find that large family size and family disruptions in childhood are negatively associated with wealth accumulation, portfolio behavior, and wealth mobility in adulthood. My analyses suggest that family size is a more important factor determining wealth accumulation for whites than for blacks or Hispanics and that family disruption is most strongly related to wealth outcomes for Hispanics. I find that family structure in adulthood is only modestly associated with overall wealth but strongly related to portfolio behavior and wealth mobility and that these relationships are relatively fixed across racial groups. My findings lend support to arguments about the importance of the role that resource dilution plays in determining life outcomes. They also suggest that efforts to reduce racial inequality in wealth ownership may be most effective if they seek to reduce the impact of deprivation early in life.

Inferring Periodic Variability of Private Market Returns as Measured by σ from the Range of Value (Wealth) Outcomes over Time

This article offers an objective mechanism for computing the periodic risk of a private investment portfolio. Such determination was derived by examining the dispersion of the portfolio investments’ terminal wealth. A portfolio manager can use the tools offered to compare the risks and returns of private and public market investments and to determine optimal asset allocation. Additionally, in evaluating private investment managers, a portfolio manager can use the equations derived in this article to determine the implied periodic risks being taken.

A Note on Risk Seeker Portfolio Selection and Lender Constraints

Risk seekers are those individuals possessing utility (U) of wealth (W) functions such that dU/ dW > 0 and d2U/dW2 > 0. Possibly because the pursuit of any consistent strategy of risk seeking over many investment periods would almost certainly lead to disaster (i.e., gamblers' ruin), such behavior has been almost totally ignored in the literature. However, as the risk seeker does prefer more to less, there appear to be no grounds to rule him irrational a priori by Von-NeumannMorgenstern tenets. The question as to whether some individuals practice risk seeking over many periods, or groups of individuals do so over fewer periods, is an empirical one which, at least to us, is far from settled. There are several compelling reasons for an investigation into risk seeker portfolio selection. Individuals possessing monotonically increasing utility functions with a convex segment [3;5] and faced with a one-period portfolio decision involving wealth outcomes which all fall in the convex

Monte Carlo Evaluation of Life Insurance Strategy

This paper describes an experiment in which the Monte Carlo method is applied to the problem of evaluating alternative life insurance strategies. A hypothetical family is modeled and family wealth is observed during a forty year life cycle under a variety of assumptions concerning life insurance and other financial decisions. The basic objective is exploration of methodological adequacy for evaluating life insurance strategy. The model is used to gather general insights as to preference for different strategies under stochastic dominance ordering rules. A methodology for estimating the cost of life insurance protection is also explored. The evaluation of life insurance strategy is an important part of the problem of consumer choice. Viewed in the framework of time-state preference,1 the insurance decision is a significant factor in determining uncertain wealth outcomes. This is clearly evident in the increasing attention devoted to such variables as uncertainty of lifetime and bequest motivation in models of consumer choice.2 But theoretical models are difficult to operationalize. In view of the variety of available life insurance programs, with complex and time-variant costs and benefits, realistic insurance models are mathematically intractable. Operational techniques for solving insurance models are also elusive. Stochastic dynamic programming, for example, is an attractive and logical framework for choice models. But algorithms are not available for extended time horizons and data deficiencies are severe. Cross-section panel data exist but individual time series of consumption, savings and wealth do not. In view of the mathematical and empirical problems involved, simulation is a promising alternative methodology. This paper discusses the construction, operation and testing of a Monte Carlo insurance model. It introduces Anthony J. Curley, Ph.D., C.P.A., is Associate Professor of Finance in The Pennsylvania State University. His earlier teaching was at St. Joseph's College and The Wharton School. This paper was submitted in June, 1973. This study was made possible by a research grant from the American Risk and Insurance Association. Additional support and computer resources were made available by the P.S.U. Center for Research of the College of Business Administration. The author is indebted to Richard Parli for research assistance, to R. Burr Porter for useful comments on an earlier draft, and to participants at the 1973 Risk Theory Seminar for their comments and encouragement. 'See Arrow [1], Debrew [5] and Hirshleifer [11]. 2Insurance has been considered in theoretical choice models by, among others, Fama [6], Hakansson [9], Meade [15], Merton [16], Samuelson [21] and Yaari [24, 25].

Fallacy of the log-normal approximation to optimal portfolio decision-making over many periods

The fallacy that a many-period expected-utility maximizer should maximize (a) the expected logarithm of portfolio outcomes or (b) the expected average compound return of his portfolio is now understood to rest upon a fallacious use of the Law of Large Numbers. This paper exposes a more subtle fallacy based upon a fallacious use of the Central-Limit Theorem. While the properly normalized product of independent random variables does asymptotically approach a log-normal distribution under proper assumptions, it involves a fallacious manipulation of double limits to infer from this that a maximizer of expected utility after many periods will get a useful approximation to his optimal policy by calculating an efficiency frontier based upon (a) the expected log of wealth outcomes and its variance or (b) the expected average compound return and its variance. Expected utilities calculated from the surrogate log-normal function differ systematically from the correct expected utilities calculated from the true probability distribution. A new concept of ‘initial wealth equivalent’ provides a transitive ordering of portfolios that illuminates commonly held confusions. A non-fallacious application of the log-normal limit and its associated mean-variance efficiency frontier is established for a limit where any fixed horizon period is subdivided into ever more independent sub-intervals. Strong mutual-fund Separation Theorems are then shown to be asymptotically valid.