Labor Flexibility and Portfolio Choice in a Life-Cycle Model, Bodie, Merton, Samuelson (1992)

I figured I’d continue with a few more blogs about life-cycle/glidepath papers…

This is the paper that is responsible for most of the legitimacy and popularity of glidepaths. Merton and Samuelson both won a Nobel prize for other work. And Bodie is no slouch himself.

They show that your career can be treated as a kind of asset. Honestly, I don’t totally follow the math but they seem to assume that you career should be treated as mostly a risk-free asset (like bonds). I’m not sure how they got there but I guess it isn’t too far off. Careers might not be as safe as Treasuries but they usually show a lot less volatility & risk than equities. As you “use up” your career-asset, you need to replace it with actual bonds.

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At the end of all their math, they have a graph showing something like a glidepath as one ages. Their insights are based on the life-cycle model which is the theory that people try to smooth consumption and leisure over their lives.

(There appears to be some recent research calling into question whether people actually perform this smoothing, however. Here’s a Bloomberg article about some of the research in the area, though I don’t pretend to guess at whether it affects Bodie et al’s conclusions.)

I found it a bit hard to know what to make of this paper. They have six main findings. Overall their model seems to be descriptive rather than proscriptive. That is, they’re saying “this is how people will behave (if they are rational)” not “this is how they ought to behave”.

That leaves with two unsettling thoughts. Even if this is how people do behave…maybe doing something different actually would lead to better outcomes? I think this is, implicitly, the argument that Basu & Drew or Arnott et al are making. “Ignore what the life-cycle model tells you to do.”

The other unsettling thought is: if this is how people already are behaving then why do we need lifecycle funds and glidepaths at all? People will already be doing all of this. I don’t think there’s ever been much empirical evidence showing that investors increased their bond holdings in any kind of systematic way. At least, none that I’ve seen. Is that evidence that they are irrational? How do we interpret the apparent disagreement between the results in this paper and what people actually do?

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