The Portfolio Size Effect and Lifecycle Asset
Allocation Funds: A Different Perspective

Abstract

Basu and Drew (in the JPM Spring 2009 issue) argued that lifecycle asset allocation strategies are counterproductive to the retirement savings goals of typical individual investors. Because of the portfolio size effect, most portfolio growth will occur in the years just before retirement when lifecycle funds have already switched to a more conservative asset allocation. In this article, Pfau uses the same methodology as Basu and Drew, but does not share their conclusion that the portfolio size effect soundly overturns the justification for the lifecycle asset allocation strategy. Although strategies that maintain a large allocation to stocks do provide many attractive features, the authors aim to demonstrate that a case for supporting a lifecycle strategy can still be made with modest assumptions for risk aversion and diminishing utility from wealth. Their conclusion differs from the results of previous studies due to four factors: 1) they compare the interactions between different strategies; 2) they consider a more realistic example for the lifecycle asset allocation strategy; 3) they examine the results for 17 countries; and 4) they provide an expected utility framework to compare different strategies. Bruno and Chincarini find that, with a moderate degree of risk aversion, investors have reason to prefer the lifecycle strategy in spite of the portfolio size effect.