Default Investment Options in Defined Contribution Plans: A Quantitative Comparison
12 Pages Posted: 14 Apr 2008 Last revised: 29 Sep 2009
Date Written: March 1, 2007
With the passage of the Pension Protection Act of 2006 and the Department of Labor regulation regarding qualified default investment alternatives, automatic enrollment and default investments featuring more equities are likely to become more popular. This analysis compares the investment performance of a balanced fund and a lifecycle fund, using average asset allocations observed on the market. Simulations show that the balanced fund is more likely to outperform the lifecycle fund, but its more aggressive approach also leaves plan participants vulnerable to losses as retirement approaches. The lifecycle fund is better at safeguarding wealth in a downward market, while still doing a reasonable job of building wealth. The typical lifecycle fund, however, with a large cash position at retirement, forgoes hedging opportunities for the purchase of immediate life annuities. Neither fund is a sure win over the near-risk-free Treasury Inflation-Protected Securities.
Keywords: Balanced and Lifecycle Funds, Qualified Default Investment Alternatives (QDIAs), Defined Contribution Plans, Pension Protection Act
JEL Classification: G11, G18, G23, J32, D14
Suggested Citation: Suggested Citation
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By Wade D. Pfau