JamesG wrote:"You state the problem very clearly: two goals require two instruments.
You raise an interesting philosophical question in your second paragraph: that is, how should one think about arriving at a value for the "safe" asset proportion in the aspirational portfolio? Without having yet given it much thought, I would have assumed that the aspirational portfolio should have a very high equity orientation. With low-return inflation-protected securities doing so much heavy lifting in the flooring portfolio, I think I will struggle with the idea of allocating much more than about 10% of the aspirational portfolio to bonds (and this only to pick up some rebalancing gains). I guess this question can only be answered by an introspective assessment of one's own risk preferences, and a realistic evaluation of one's likely resources at retirement: perhaps the higher one sets the level of flooring income, the lower should be the bond allocation in the aspirational portfolio; likewise, the higher one's likely assets at retirement, the lower can be the bond allocation in the aspirational portfolio.
There is only one portfolio in life-cycle investing, but there are two retirement income strategies. One is matching for the floor and the other is a diversified strategy to get from the floor income to the aspirational level of income. This distinction between strategies and portfolios is important, because typically if the diversified portion of the portfolio does well one transfers assets and raises the safe floor nearer to the aspirational income level. One does not keep the floor and redefine the aspirational level up. Conversely, if the diversified portion of the portfolio does poorly, you keep the safe floor but choose some combination of the following options with regard to the diversified portion - save more, retire later, take more risk, or lower the aspirational retirement income goal. Unfortunately, each of these four options has a downside, which is a key reason you want a truly safe floor strategy in addition to the diversified assets in the portfolio.
In life-cycle investing one is serious about meeting the goals set. For retirement we set floor and aspirational levels of income and intend to meet those goals. If one sets the risk level very high in the asset allocation for the aspirational level of retirement income then you have a good chance of exceeding your aspirational level of retirement income, but if you set the risk level lower to have a high probability of hitting the goal but not much chance of exceeding it by very much, your chances of hitting or exceeding the goal are greater than with the higher risk asset allocation.
The upside of taking a lot of risk in the asset allocation (AA) for getting to your aspirational retirement income goal is that that you have a good chance of exceeding the goal - sometimes by a large amount. The downside is the extra risk means you have less chance of meeting or exceeding your goal and your chances of falling far short of your goal are increased.
The above is easiest to see with a stylized simple example. With one year to go before retirement your portfolio is 2% short of of the target portfolio level. Safe assets have real interest rates of 2.7%. Your intended savings for the year is 0.3% of the current portfolio size. Which AA gives you a greater chance of meeting or slightly exceeding or slightly falling short of your goal - one hundred percent safe assets or 50/50 risky assets-safe assets. Which AA gives you a greater chance of exceeding your goal by a significant amount? Which AA gives you a greater chance of falling far short of your goal?
All of the above is not as conservative as it may sound. When you are many years from retirement the AA for the aspirational retirement income will likely be very high, perhaps 100%, partially because you have a large amount of implicit safe assets in the expected future contributions you, and probably your employer, will be making to your retirement income. These implicit safe assets include future contributions to Social Security and DB pensions as well as your own retirement portfolio. However, as you approach retirement you will want to stay on track for meeting your goal without taking excessive risk in your portfolio, because too much risk will lower the probability of meeting the goal. In addition those implicit safe assets of expected future contributions will be greatly diminished as your near your retirement date.