Diversification Across Time

Abstract

Young people who buy stock on margin and reduce their equity exposure as they age can reduce lifetime portfolio risk. For example, an initially leveraged portfolio produces the same mean accumulation as a constant 74% stock allocation with a 21% smaller standard deviation. Since the means are equal, the reduced volatility doesn’t depend on the equity premium. A leveraged life-cycle strategy also lets investors come closer to their utility-maximizing equity allocation. Monte Carlo simulations show that the gains continue even with equity premiums well below historical levels.

TOPICS: Equity portfolio management, in markets, exchanges/markets/clearinghouses