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IMA Journal of Management Mathematics 2003 14(2):145-161; doi:10.1093/imaman/14.2.145
© 2003 by Institute of Mathematics and its Applications
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Take (smoothed) risks when you are young, not when you are old: How to get the best from your pension plan

David Blake1

1 Pensions Institute, Cass Business School, 106 Bunhill Row, London EC1Y 8TZ, UK

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

Received 13 May 2003. Revised 18 September 2003.


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