Long-Run Savings and Investment Strategy Optimization

Abstract

We focus on automatic strategies to optimize life cycle savings and investment. Classical optimal savings theory establishes that, given the level of risk aversion, a saver would keep the same relative amount invested in risky assets at any given time. We show that, when optimizing lifecycle investment, performance and risk assessment have to take into account the investor’s risk aversion and the maximum amount the investor could lose, simultaneously. When risk aversion and maximum possible loss are considered jointly, an optimal savings strategy is obtained, which follows from constant rather than relative absolute risk aversion. This result is fundamental to prove that if risk aversion and the maximum possible loss are both high, then holding a constant amount invested in the risky asset is optimal for a standard lifetime saving/pension process and outperforms some other simple strategies. Performance comparisons are based on downside risk-adjusted equivalence that is used in our illustration.