DISCUSSION PAPER PI-0304
Take (Smoothed) Risks When You Are Young, Not When You Are Old:
How to Get the Best from Your Pension Plan
Using stochastic modelling, we demonstrate that the best investment strategy
for the accumulation phase of a defined contribution pension plan is one that
limits the range of returns that are credited to the plan member’s account.
In particular, we show that with-profit accumulation programmes which make
use of a smoothing fund to smooth out returns over time dominate unit-linked
accumulation programmes. However, for the distribution phase, we show that
it is hard in practice for an investment-linked distribution programme to beat the
income and security provided by a standard annuity, although we again find that,
by avoiding extremely poor outcomes, with-profit distribution programmes dominate
unit-linked distribution programmes. Return smoothing by means of a smoothing
fund is therefore a valuable feature of any long-term investment programme both
during the accumulation and distribution phases.
Keywords: pension plan; defined contribution; stochastic modelling.