A major crisis is threatening the sustainability of pension systems across the globe. With the need to supplement public and private retirement benefits via voluntary contributions, individuals are becoming increasingly responsible for their own retirement savings and investment decisions. This global trend poses substantial challenges to individuals, who often lack the expertise required to make such complex financial decisions.
In a new publication entitled “A Holistic Goal-Based Investing Framework for Analyzing Efficient Retirement Investment Decisions in the Presence of Long-Term Care Risk,” EDHEC-Risk Institute presents a formal analysis of efficient investment strategies for individuals and households in the decumulation phase of their life-cycle. This research was conducted with the support of Bank of America as part of EDHEC-Risk Institute’s research chair on “Goal-Based Wealth Management and Applications to Retirement Investing.”
The main contribution of this paper is to develop a comprehensive and flexible framework for personalized advice on retirement investment decisions in the presence of life event risk, and with a menu of assets that includes balanced funds and target date funds, as well as a variety of annuity-related products.
In this study, the authors demonstrate that accounting for long-term care risk reduces the optimal demand for annuities, thus suggesting that the opportunity cost inherent in the expensive reversibility of annuitization decisions can help explain the annuity puzzle, i.e. the lower-than-expected demand for annuity products. They also find that the introduction of annuity products with upside potential and goal-based investing strategies securing minimum levels of replacement income has a positive impact on investor welfare.
Professor Lionel Martellini, Director of EDHEC-Risk Institute, reports that “dynamic goal-based investing principles can be used to design a parsimonious set of retirement investment strategies that meet the needs of individual investors preparing for retirement as they secure an essential level of replacement income and also have good probabilities of generating much more replacement income than what they would have obtained by investing in annuities, and this is possible in a cost-efficient and reversible format.”
According to Anil Suri, Head of Asset Allocation and Investment Analytics for the Chief Investment Office of Merrill and Bank of America Private Bank, “From an analytical perspective, the framework combines robust investment thinking with a computationally effective and efficient approach in a very compelling and practical way. Ultimately, this will help us develop more specific and refined guidance across a range of investments to help our client’s achieve their goals.”
A copy of the EDHEC-Risk Institute publication can be found here:
