Assessing Default Investment Strategies in Defined Contribution Pension Plans
The design of default investment options in defined contribution (DC) pension plans is of critical policy relevance, as many members of DC plans are incapable or unwilling to choose investment strategies among the great variety offered to them. There is increasing international consensus that some type of life-cycle strategy is desirable for default options, with decreasing risk exposure as the individual ages. However, the specific allocation to risky assets (such as equities) at different ages is a matter of much debate, both in academic and policy circles. There is also an on-going debate on the relative merits of deterministic investment strategies with a fixed glide-path over the life-cycle and dynamic strategies that take into account some supposedly long-term features of asset returns, such as mean-reversion.
The main goal of this paper is therefore to assess the relative performance of different investment strategies. This is also done for different structures of the payout phase. In particular, it looks at whether the specific glide-path of life-cycle investment strategies and the introduction of dynamic features in the design of default investment strategies affect significantly retirement income outcomes.
The paper combines a stochastic analysis of the performance of different investment strategies for different payout options with a historical analysis to test the findings of the stochastic simulation with actual market data from Japan and the United States. The stochastic model using simulations of returns of the different asset classes (cash, bonds and equities) generates, depending on the form of the payout phase, stochastic simulations of income at retirement. In the historical analysis, all the strategies examined have the same average allocation to equities during the accumulation period. Additionally, two contribution periods are considered: 40 and 20 years.