Autonomous Portfolio: A Decumulation Investment Strategy That Will Get You There

Abstract

The article’s primary contribution is applying a dynamic decision theory approach to investment management and adding spending flexibility to improve incomes for retirees for whom saving more and working longer are no longer options. We investigate whether a self-driving portfolio, engineered to protect against market risk, can deliver more income than other investment approaches while minimizing the risk of ruin. We consider whether a dynamic strategy, based on a stochastically dominant decision theory algorithm and tested with fixed and variable spending policies, can minimize the chance of running out of money before dying. Outcomes are compared with a number of static approaches.

We find that the dynamic strategy provides an average of 51% more income than a target date fund through retirement when combined with a hybrid spending rule over a relevant probability of ruin range of 1% through 25%. Furthermore, when rebalanced to constant risk rather than to fixed asset mixes, sequence of return risk can be reduced. Variable spending policies add effectiveness and should be considered regardless of investment strategy. Importantly, dynamic decision theory establishes a framework for goal-seeking solutions that may have application in other phases of the investor’s life cycle.

TOPICS: Retirement, portfolio construction, quantitative methods