Hugh H. Kim, Raimond Maurer, Olivia S. Mitchell. 2013. Time is money: life circle rational inertia and delegation of investment management. Working Paper 19732. National Bureau of Economic Research
Abstract: :We investigate the theoretical impact of including two empirically-grounded insights in a dynamic life cycle portfolio choice model. The first is to recognize that investors incur opportunity costs in terms of current and future human capital accumulation when managing their own financial wealth, particularly if human capital is acquired via learning by doing. The second is that we incorporate age-varying efficiency patterns in financial decision making. Both enhancements produce inactivity in portfolio adjustment patterns consistent with empirical evidence. We also analyze individuals’ optimal choice between self-managing their wealth versus delegating the task to a financial advisor. Delegation proves most valuable to the young and the old. Our calibrated model quantifies welfare gains from including investment time and money costs, as well as delegation, in a life cycle setting.
Conclusion:This paper develops and simulates a life cycle model to illustrate optimal portfolio management methods selected by finitely-lived investors who face portfolio management cost sand an age-dependent inefficiency pattern for financial decision-making. Using a reasonable set of parameters, our model replicates observed patterns of portfolio inertia across age groups.
Investors who can accumulate job-specific knowledge by working tend to devote less time to managing their money when they are young. Middle-aged both have more assets to invest and suffer less from the opportunity costs of self-managing their assets, though many still elect inertia. Declining decision-making efficiency later in life prompts many older investors to select portfolio inertia. When investors can delegate the portfolio management task to a financial advisor, this enables many to avoid portfolio inertia. In general, the model predicts that older investors will find financial advisors most attractive. Finally, we find rather substantial welfare gains resulting from having a delegation option.
Our findings are relevant to a variety of stakeholders including individual investors, financial advisors, retirement plan sponsors, and policymakers. Those who will value financial advisory services the most are the young and the older age groups, so making such services available can greatly enhance their well-being. Also of interest is the prediction that advisors will find that some middle-aged clients will wish to continue self-managing their own financial assets, even when a delegation option is available. Policymakers may also wish to consider the potential positive welfare gains of improving investor access to financial advisory services. In an environment where financial advisors with fiduciary responsibility can help investors manage their financial wealth optimally, this will enable more people to accrue job-specific skills, thus contributing to the economy as a whole.