The effect of objective formulation on retirement decision making

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Journal Article

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Butt, A., & Khemka, G. (2015). The effect of objective formulation on retirement decision making. Insurance: Mathematics and Economics, 64, 385-395.

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Copyright © 2015 Elsevier B.V. All rights reserved.

2015 HERDC submission




For a retiree who must maintain both investment and longevity risks, we consider the impact on decision making of focusing on an objective relating to the terminal wealth at retirement, instead of a more correct objective relating to a retirement income. Both a shortfall and a utility objective are considered; we argue that shortfall objectives may be inappropriate due to distortion in results with non-monotonically correlated economic factors. The modelling undertaken uses a dynamic programming approach in conjunction with Monte-Carlo simulations of future experience of an individual to make optimal choices. We find that the type of objective targetted can have a significant impact on the optimal choices made, with optimal equity allocations being up to 30% higher and contribution amounts also being significantly higher under a retirement income objective as compared to a terminal wealth objective. The result of these differences can have a significant impact on retirement outcomes.

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