Shocks to Income in a Lifecycle Model: An Undervalued Risk

ABSTRACT Lifecycle models are increasingly popular in financial planning, but many planning‐oriented implementations simplify 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 updates income‐process estimates using PSID data from 1984 to 2019 and evaluates how those estimates affect model‐implied 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 accounting for income shocks enhances retirement planning by increasing savings rates and better aligning asset allocations with clients' financial stability. Income‐process parameters are estimated empirically using the data from the Panel Study of Income Dynamics (PSID), while saving‐rate and equity‐allocation recommendations are derived from simulations of a lifecycle model calibrated to those estimates.