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

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  • Anup K. Basu
  • Michael E. Drew

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.
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  • Anup K. Basu & Michael E. Drew, 2009. "The Appropriateness of Default Investment Options in Defined Contribution Plans: Australian Evidence," Discussion Papers in Finance finance:200903, Griffith University, Department of Accounting, Finance and Economics.
    • Handle: RePEc:gri:fpaper:finance:200903
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    Cited by:

    1. Kirsten L. MacDonald & Robert J. Bianchi & Michael E. Drew, 2020. "Equity risk versus retirement adequacy: asset allocation solutions for KiwiSaver," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3851-3873, December.
    2. Luković Stevan & Marinković Srđan, 2019. "Comparative Analysis of Retirement Benefits in Private Pension Funds and Public Pension System," Economic Themes, Sciendo, vol. 57(2), pages 145-164, June.
    3. Liam A. Gallagher & Fionnuala Ryan, 2017. "A Portfolio Approach to Assessing an Auto-Enrolment Pension Scheme for Ireland," The Economic and Social Review, Economic and Social Studies, vol. 48(4), pages 515-548.
    4. John Burnett & Kevin Davis & Carsten Murawski & Roger Wilkins & Nicholas Wilkinson, 2018. "Measuring the Adequacy of Retirement Savings," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 64(4), pages 900-927, December.
    5. Amandha Ganegoda & John Evans, 2017. "The Australian retirement lottery: A system failure," Australian Journal of Management, Australian School of Business, vol. 42(1), pages 3-31, February.
    6. Adam Butt & M. Scott Donald & F. Douglas Foster & Susan Thorp & Geoffrey J. Warren & Tom Smith, 2017. "Design of MySuper default funds: influences and outcomes," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 57(1), pages 47-85, March.
    7. Wilson Sy, 2009. "Towards a national default option for low‐cost superannuation," Accounting Research Journal, Emerald Group Publishing Limited, vol. 22(1), pages 46-67, July.
    8. Panha Heng & Scott J. Niblock & Jennifer L. Harrison, 2015. "Retirement policy: a review of the role, characteristics, and contribution of the Australian superannuation system," Asian-Pacific Economic Literature, The Crawford School, The Australian National University, vol. 29(2), pages 1-17, November.
    9. Sergey A. Budko & Dmitry Yu. Fedotov, 2017. "World Experience and Russian Practice of the Pension System’s Revenue Formation: Mathematic Methods of Estimation," Journal of Tax Reform, Graduate School of Economics and Management, Ural Federal University, vol. 3(3), pages 199-215.
    10. Sullivan, Nikki & Breslav, Alexander & Doré, Samyukta & Bachman, Matthew & Huettel, Scott A., 2025. "The golden halo of defaults in simple choices," LSE Research Online Documents on Economics 126086, London School of Economics and Political Science, LSE Library.
    11. Humphrey, Jacquelyn E. & Benson, Karen L. & Low, Rand K.Y. & Lee, Wei-Lun, 2015. "Is diversification always optimal?," Pacific-Basin Finance Journal, Elsevier, vol. 35(PB), pages 521-532.
    12. Lhaopadchan, Suntharee & Gerrans, Paul & Treepongkaruna, Sirimon, 2024. "Retirement savings behaviours and COVID-19: Evidence from Thailand," Pacific-Basin Finance Journal, Elsevier, vol. 85(C).
    13. Gordon L. Clark & Emiko Caerlewy‐Smith & John C. Marshall, 2009. "Solutions to the Asset Allocation Problem by Informed Respondents: The Significance of the Size‐of‐Bet and the 1/N Heuristic," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 12(2), pages 251-271, September.
    14. Peng, Xiaowen & Alpert, Karen & Hsu, Grace Chia-Man, 2020. "Switching between superannuation funds: Does performance and marketing matter?," Pacific-Basin Finance Journal, Elsevier, vol. 63(C).

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    More about this item

    Keywords

    Defined contribution plan; Default option; Asset allocation; Downside risk; Lower partial moment; Value at risk; Expected tail loss;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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