How Good Are Default Investment Policies in Defined Contribution Pension Plans?

Abstract

Defined contribution (DC) pension plans have been gaining ground in the last 10-20 years as the preferred system for many countries and other agencies, both private and public. The central question for a DC plan is how to invest in order to reach the participant's retirement goals. Given the financial illiteracy of the general population, it is common to offer a default policy for members who do not actively make investment choices. Using data from the Chilean system, we discuss an investment model with fixed contribution rates and compare the results with the default policy under multiple objectives. Our results indicate that the Chilean default policy has a good overall performance, but specific closed-loop policies have a higher probability of achieving desired retirement goals and can reduce the expected shortfall at retirement.

Keywords: Defined Contribution, Closed-Loop Policies, Dynamic Programming, Utility Functions, Stochastic Dominance

JEL Classification: H55, D81, C61