What's in Your 403(B)? Academic Retirement Plans and the Costs of Underdiversification

Abstract

Many college and university 403(b) plans restrict investment choices to the funds offered by TIAA-CREF, the current manager of over half of all 403(b) contributions. In the face of 2006 Internal Revenue Code changes some sponsors are dropping alternatives to TIAA-CREF. Using historical data, we study the efficiency of the TIAA-CREF opportunity set relative to a larger set that includes several standard index funds. Assuming optimal rebalancing, depending on loss-aversion, financial sophistication, and diversification constraints, over a forty-year work-life, an employee who is restricted to TIAA-CREF could lose more than half of terminal wealth, compared to investing in the expanded menu. Even when a naïve diversification strategy of equally weighting (1/n) all available funds is used, the expanded menu outperforms the restricted portfolio by about one-third over the employee's work-life.

Keywords: Pension policy, retirement savings, portfolio selection, diversificaiton, Tiaa-Cref, ERISA

JEL Classification: G11, G23, D14, G28, G18, H24