Unconventional wisdom:The professor who thinks Australians need to own more shares
A model out of Yale University suggests many super strategies are too conservative.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: The professor who thinks Australians need to own more shares
“The enemy of a good asset allocation is the quest for a perfect one. Fight the urge to be perfect.”
- Richard Ferri
At the beginning of July 2024 Australian Retirement Trust (“ART”) made a substantial change that will impact the retirement outcomes of 1.4 million Australians.
Any member under the age of 50 in ART’s My Super option was switched from balanced to high growth. This increased the allocation to growth assets from 70% to 85%.
My Super is the default and over 65% of super accounts with more than 6 members are in the My Super option. With many Australians disengaged with super the default option matters.
My Super was part of super reform legislation in 2012 and most super funds set the balanced option as the default.
A professor from Yale thinks this is a mistake. His model shows the balanced option is too conservative for most investors under 55 years old. But he doesn’t stop there - he also thinks the ART high growth option is too conservate for many people. Understanding his thinking might help you improve your retirement.
Practical finance
The more Professor James Choi at the Yale School of Management looked at the approach most people took to personal finance, the more he sensed there was a problem. Some advice relied on simplistic and unrealistic rules of thumb. Some relied on numerical calculations that were applicable in only very specific situations.
Choi has chosen to focus on the middle ground which he calls ‘practical finance.’ The goal is to come up with “analytical approximations to optimal solutions as a function of relevant parameters in realistic settings that are easily computed in a spreadsheet.”
Choi has some work to do on describing his research in a straightforward manner. But what he is trying to do is apply economic theory to common personal finance challenges to come up with approximate guidance that everyone can follow.
In a recent paper Choi tried to apply his concept of practical finance to asset allocation. This is one of the most important decisions any investor can make. Despite all the attention lavished on picking individual shares and ETFs the biggest driver of returns is asset allocation. This makes the My Super default plan so critical to retirement outcomes.
Investors are often encouraged to self-assess their risk tolerance to make decisions on asset allocation. The risk tolerance approach means the less comfortable you are with volatility the more of your portfolio should be in defensive assets like bonds.
Choi uses risk tolerance as one input into his model. But he also incorporates other factors including future income streams people will likely receive.
An academic paper titled Consumption and portfolio choice over the life cycle informs Choi’s work. The basic premise is that your future wages and any guaranteed retirement benefits like the age pension play the role of fixed interest in your life. That ‘fixed interest’ equivalent allows you to allocate more of your portfolio to shares.
Test driving Choi’s model
I put Choi’s model through the paces. The first set of scenarios I ran assumed no age pension. I took the median super balance for five-year ranges for both men and women. I also used the median salary for Australians in each age range and assumed an annual salary increase consistent with inflation. I assumed no financial assets or debt outside of super.
I adjusted the risk tolerance measure to get a range of suggested allocations to shares. I also ran the middle risk tolerance scenario which is a 5 on Choi’s 10-point scale. I’ve assumed that our hypothetical super investor is single. Below are the results:
As a point of reference, the My Super balanced option from AustralianSuper has a 24% defensive allocation as of 31 December 2025. From a mid-point risk tolerance that is more conservative than Choi would recommend for any investor under 55 years old.
The ART high growth option allocates 15% to defensive assets. From a mid-point risk tolerance that is more conservative than Choi would recommend for any investor under 55 years old.
One thing that jumps out is the suggested equity allocation for women is higher than men. This is by design as Choi believes the more money you have the more conservative you should be. Since men have higher super balances, the model suggests lower equity allocations.
Putting the age pension into Choi’s model
Choi considers future wages a type of fixed interest. The more human capital a person has the more they can invest in volatile shares. Another equivalent to fixed interest is any regular payments in retirement. This could be a reverse mortgage, annuity or the age pension.
I added an annual age pension of $28,054 which is the current maximum yearly rate for a single person. The model assumes any cash flows rise by inflation which approximates the inflation adjustments to the age pension.
I kept all the other assumptions the same. The following chart shows the results:
The inclusion of the age pension has increased the suggested allocation to shares. Once somebody gets into their mid to late 50s it pushes the suggested allocation upwards for investors with low-risk tolerances.
Interestingly the mid-point risk tolerance suggests a 100% allocation to shares across all age groups. This meaningfully exceeds the balanced option for AustralianSuper and the ART high growth option.
The reason Choi’s model is suggesting 100% of a portfolio should be in shares is because it is taking a more holistic view of an individual’s financial situation. Super funds know little about their members. That puts the onus on individuals to make the necessary adjustments to their investing strategy.
Lessons learned
Lesson one: Many people invest too conservatively
Most Australians are in balanced super funds. While the asset allocation varies across different super providers AustralianSuper can be used as a proxy with their 24% defensive allocation. That is too high for many people with decades to ride out volatility before retirement.
Choi’s model also validates the decision ART made by switching their My Super option to high growth. I believe this will better the lives of many of their members – whether they paid attention to the change or not. More super funds should follow their lead.
Lesson two: Your human capital matters and needs to be replaced by financial capital
Too much financial guidance relies on rules of thumb. Instead, Choi is taking a more holistic view of an individual’s financial circumstances. Human capital is an asset, and your future wages should be considered as part of your financial situation.
As you age your human capital diminishes, which is why it is so critical to build up financial capital to replace it. That is a lesson that should be taught to people early in life.
Lesson three: Future income streams have a value but aren’t invaluable
The model calculates the value of future streams of income like wages or the age pension. For instance, the $28,054 annual age pension payout for a 65-year-old retiree is worth $534,911 today. To calculate that value there are lots of assumptions built into the model about life expectancy and discount rates.
The point is that you can value the age pension and compare that to the value of other assets. I keep hearing stories about retirees in very expensive homes that won’t sell. They are worried about losing the age pension since a primary residence is exempt from the means test.
There may be other reasons for holding onto a home. It could be an inheritance people want to pass along or perhaps they just don’t want to move. However, if it is about getting the most utility out of financial assets it makes little sense to forgo $2 million to hold onto something worth $500,000.
Final thoughts
There is one critical thing missing from Choi’s model. There is no attempt to account for goals.
How much you allocate to shares is not about your risk tolerance or your current account balance. It is about the return you need to get what you want out of life.
None of us is just a utility maximising entry on a spreadsheet, no matter how much economists want us to be. We all have hopes and dreams for the future. Those hopes and dreams are worth the sacrifice of saving money. They are worth withstanding some volatility.
Focus on your risk capacity. That is the amount of volatility you need to withstand to achieve your goal. Professor Choi invented practical finance. I’m still partial to personal finance because success doesn’t come from being practical. It comes from making sure your plan is personal.
If you need some help with setting goals and figuring out your risk capacity email me at mark.lamonica1@morningstar.com
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What I’ve been eating
In 1909 an Italian immigrant named Frank Pepe arrived in New Haven Connecticut. After serving in the first world war he returned to New Haven and started what the kids call a side hustle. Selling pizza from a wagon worked out well for Frank and soon he was able to open his own pizza place. I love Frank Pepe’s pizza.
Frank Pepe started New Haven style pizza. Thin crust and cooked at high temperature in coal ovens, New Haven style is my ideal pizza. If you ever find yourself in New Haven go to Frank Pepe…and then Sally’s and then Modern. Thank me later.
Naturally, I was excited when AP Bakery opened a New Haven style pizza place close to my apartment. Whatever they make at Appizza is not the same – but it is pretty good. The pictured slice of pepperoni costs $10 which is a helpful reminder that investing in growth assets is important.
