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

John Angus, William O. Brown, Janet Smith and Richard Smith ()

Financial Management, 2007, vol. 36, issue 2, 1-38

Abstract: Sponsors of defined contribution retirement plans typically limit the investment choices of plan participants to a small number of investment managers and a limited number of investment vehicles. Such restrictions may limit excessive risk‐taking by participants but also may preclude opportunities for efficient diversification. Many college and university 403 (b) plans have restricted investment choices to the retirement annuities offered by TIAA‐CREF, the current manager of over half of all 403(b) contributions. Using 10 years of historical data, we study the efficiency of this TIAA‐CREF opportunity set relative to a larger set that includes several standard index funds. Extrapolations must be interpreted ‐with caution. Assuming optimal rebalancing, depending on loss aversion and diversification constraints, the historical sample of returns implies that over a 20‐year remaining work life, an employee ‐with an expanded menu that includes standard index funds could gain over 40% in terminal wealth compared to one who is restricted to TIAA‐CREF retirement annuities. Even when a naive diversification strategy of equally weighting (1/n) all available funds is used, the expandedmenu outperforms the restricted portfolio by more than 25% over20years. These differences generally are significant at conventional levels based on parametric and nonparametric testing and do not appear to result from idiosyncratic market performance durinz the sample period.

Date: 2007
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