NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Publications by Jialun Li

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with Kent Smetters
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May 2011Optimal Portfolio Choice with Wage-Indexed Social Security
with Kent Smetters: w17025
This paper re-examines the classic question of how a household should optimally allocate its portfolio between risky stocks and risk-free bonds over its lifecycle. We show that allowing for the wage indexation of social security benefits fundamentally alters the optimal decisions. Moreover, the optimal allocation is close to observed empirical behavior. Households, therefore, do not appear to be making large "mistakes," as sometimes believed. In fact, traditional financial planning advice, as embedded in "target date" funds – whose enormous recent growth has been encouraged by new government policy – often leads to even relatively larger "mistakes" and welfare losses.

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