Appropriateness of Default Investment Options in Defined Contribution Plans: The Australian Evidence

Anup Basu and Michael Drew

MPRA Paper from University Library of Munich, Germany

Abstract: For participants in defined contribution (DC) plans who refrain from exercising investment choice, plan contributions are invested following the default investment option of their respective plans. Since default investment options of different plans vary widely in terms of their benchmark asset allocation, the most important determinant of investment performance, participants enrolled in these options face significantly different wealth outcomes at retirement. This paper simulates the terminal wealth outcomes under different static asset allocation strategies to evaluate their relative appeal as default investment choice in DC plans. We find that strategies with moderate allocation to stocks are consistently outperformed in terms of upside potential of exceeding the participant’s wealth accumulation target at retirement as well as downside risk of falling below that target outcome by very aggressive strategies whose allocation to stocks approach 100%. The risk of extremely adverse wealth outcomes for plan participants also does not appear to be very sensitive to asset allocation. Our evidence strongly suggests the appropriateness of strategies heavily tilted towards stocks to be nominated as default investment options in DC plans unless plan providers emphasize predictability of wealth outcomes over adequacy of retirement wealth.

Keywords: defined contribution; default option; asset allocation; retirement wealth; downside risk (search for similar items in EconPapers)
JEL-codes: G11 G18 G23 (search for similar items in EconPapers)
Date: 2006-05, Revised 2006-11-02
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The appropriateness of default investment options in defined contribution plans: Australian evidence (2010)
Working Paper: The Appropriateness of Default Investment Options in Defined Contribution Plans: Australian Evidence (2009)
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