Optimal Asset Allocation for Early Retirement Portfolios

Martin Fremming Lainchbury & Elisabeth Abner

Student thesis: Master thesis


The objective of this thesis is to find the optimal asset allocation for retirement portfolios in the accumulation and decumulation phase for people retiring prior to the statutory age. This is followed by a comparison with empirical data to determine if investors are following an opti-mal allocation. Four portfolios are constructed for this purpose with two models for each phase. These portfolios are the foundation for answering our research questions on what the optimal allocation is and whether retirement portfolios are aligned with it.

We find it essential to present the underlying motivations, assumptions and components prior to answering the research questions in order for the reader to obtain a comprehensive under-standing of the models. This is done by devoting chapters to the Financial Independence, Retire Early (FIRE) movement, asset classes, methodology and model construction.

Our models are based on data from the beginning 1960 to end 2019, thus covering a 59-year period. This has allowed us to capture numerous business cycles and obtain results which apply to both bull and bear markets. The optimal portfolios are built on acquired and simulated monthly returns for equities and bonds, adjusted for inflation. The allocations indicated by the optimal models are compared with data from the Employee Benefit Research Institute (EBRI). The EBRI data set includes 27.1 million participants and assets of more than USD 2 trillion.

The four optimal models should be considered as two pairs which both amount to a total of 60 years spent in the accumulation and decumulation phase. The first pair entails 15 years in the accumulation phase followed by 45 years in the decumulation phase. The second pair entails an accumulation phase of 20 years and a decumulation phase of 40 years. The combined period of 60 years has been determined based on the average life expectancy and when people, who retire prior to the statutory age, typically start saving. The final models have each been based on 100,000 simulations using Monte Carlo methods.

We find that empirical retirement portfolios are overweight in equities compared to the optimal models in both the accumulation and decumulation phase. The risk-return relationship of retir-ees’ portfolios in the accumulation phase could be maximized by devoting a larger share to fixed income investments. In the decumulation phase, investors are not adequately rebalancing portfolios, and thus continue with the objective of generating instead of preserving wealth.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final ThesisMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2020
Number of pages114
SupervisorsNatalia Khorunzhina