Saving for Retirement: Optimal Decisions vs. Simple Heuristics

Abstract

Pension plan participants' characteristic lack of financial sophistication and widespread failure to monitor investments frequently prompts expressions of concern about the potentially large welfare losses such individuals could suffer. I explore this issue by studying the performance of an unsophisticated individual employing the so called "1/n strategy" of Benartzi and Thaler (2001) in a sample of defined contribution pension plans, finding that for typical investors, the out of sample impact of following this heuristic is insignificantly small. Moreover, lack of frequent monitoring, reflected in the absence of rebalancing and re-estimation of the initial asset allocation, does not seem to be costly at all. This stands in contrast to estimates based on calibrated models or obtained assuming that the data generating process is known with certainty. Using this simple heuristic does not seem necessarily irrational then, especially in consideration of the time and effort required to make optimal investment decisions.