Wealth accumulation and portfolio choice with taxable and tax-deferred accounts

1. Wealth accumulation and portfolio choice with taxable and tax-deferred accounts Francisco Gomes, Alexander Michaelides, Valery Polkovnichenko Discussion by: Otto van Hemert March 2005

2. Household wealth accumulation and portfolio choice For both direct stockholders (DS), and indirect stockholders (IS) In both the Taxable Account (TA), and Tax-deferred account (TDA) Main focus on accumulation phase where uninsurable labor income risk figures prominently The paper

3. Match empirical stock market participation and asset allocation in a life-cycle model Key features disentangle risk aversion and elasticity of intertemporal substitution (EIS) a la Epstein-Zin (1989). fixed stock market entry cost heterogeneity in risk aversion Make no difference TA and TDA Less focus on wealth accumulation Paper is part of a larger research agenda: Gomes-Michaelides (2004)

4. Discuss empirical evidence on wealth accumulation and portfolio choice for DS and IS in TA and TDA separately Develop life-cycle model and find investor preferences that match empirical evidence Implications sub-optimal contribution rates to TDA Impact introduction TDAs on wealth accumulation and asset allocation Four contributions

5. Us population divided by stockholder status 1998 2001 Non-stockholders: 65.4% 47.1% Indirect stockholders: 13.6% 21.4% Direct stockholders: 21.0% 31.5% Differences DS vs. IS DS have more significant financial savings in TA; IS basically have their net-housing wealth as TA DS have higher wealth/income ratio. Empirical findings

6. The preference parameters: DS: high risk-aversion, high EIS IS: low risk-aversion, low EIS Empirical fact that DS have higher wealth/income ratio is matched High risk-aversion  high precautionary saving High EIS  willingness to exploit high return on savings by postponing much consumption Known puzzle that retirees decumulate too slow remains… The life-cycle model

7. GMP justify this by noticing the empirical liquid taxable wealth is too little too pay a one-time stock market participation cost But in the model net housing wealth is included in taxable wealth?! DS can invest this in stocks Somewhat inconsistent attitude towards net housing wealth Deeper question: can you increase mortgage to consume or invest the proceeds? Exogenous assumption that IS hold no stocks in TA

8. Economic story behind tying high (low) risk aversion to high (low) EIS? Empirically, who are the DS and IS? Labor income level Education (proxy for intelligence) Female or male head of household Number of car accidents involved in If eg income level matters, then scale independent model might be misleading Provide further intuition on the difference between DS and IS

9. Cost of following a fixed contribution rate is small. Cost of “one-size-fits-all” is high If a fixed contribution rate is imposed, then optimally set it below average from optimal decisions GMP: too low consumption for liquidity constrained young is very costly Also over-investment in TDA is harder to compensate (in TA) than under-investment in TDA? Related to Adair Turner’s presentation last Tuesday Extension: sub-optimal contribution rates to TDA

10. In the presence of a TDA, some households hold stocks only indirectly (exogenous in model, justification discussed) What if those same households are confronted with a situation with no TDA? They might start to invest in stocks themselves! Cannot maintain exogenous assumption they do not invest in stocks in TA Extension: introduction of a TDA

11. A nice and ambitious paper! Better justify exogenous non-participation in stock market by IS Provide further intuition on the difference between DS and IS Is the analysis on the impact of the introduction of a TDA not too much? Concluding Remarks