Shocks to Income in a Lifecycle Model: An Undervalued Risk

Abstract

Lifecycle models are increasingly popular in financial planning. However, they often overlook the significant risk posed by income shocks—such as career disruptions, economic downturns, or technological advancements—that can affect financial plans, including retirement. This paper explores the role these shocks have on shaping saving rates, financial capital accumulation, and asset-allocation decisions, with particular attention to the possible relationship between income shocks and equity returns. By integrating industry-specific income risk into asset-allocation decisions, this research provides practical insights for financial advisors seeking to personalize investment strategies based on clients’ career paths, education levels, and industry volatility. The findings suggest that adjusting for income shocks can significantly improve retirement planning and improve alignment of asset allocations with clients’ financial stability by increasing saving rates and adjusting equity exposure in portfolios.

Sebastian Gomez-Cardona

Director of Research

I am Director of Research in Investment Advice and Planning at Morningstar Retirement.