What Drives Investors' Portfolio Choices? Separating Risk Preferences from Frictions

From Taha Choukhmane and Tim de Silva

We study the role of risk preferences and frictions in portfolio choice using variation in 401(k) default options. Patterns of active choice in response to different default funds imply that, absent participation frictions, 94% of investors prefer holding stocks, with an equity share of retirement wealth declining with age—patterns markedly different from observed allocations. We use this quasi-experiment to estimate a life-cycle model and find a relative risk aversion of 2.5, elasticity of intertemporal substitution (EIS) of 0.25, and $160 portfolio adjustment cost. The results suggest that low levels of stock market participation in retirement accounts are due to participation frictions rather than nonstandard preferences such as loss aversion.

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In a companion white paper with T. Rowe Price, Choukhmane and de Silva build on the paper to show that investor preferences grow more heterogeneous with age, pointing to the value of more personalized products beyond target date funds for older savers.

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Learn More about Retirement

Current Retirement projects from the Consumer Finance Initiative cover topics including Target Date Funds, retirement savings and portfolio choices, and racial gaps in retirement savings.  Find more Retirement research here.