A comparison of state university de®ned bene®t and de®ned contribution pension plans

Abstract


 
 
 This paper examines investment risk in comparing de®ned benefit (DB) and de®ned contribution (DC) plans by employing a Monte Carlo simulation. Using a bivariate normal distribution, two general types of risk are associated with a DC-plan. The ®rst is that not enough is being earned by an allocation rule to cover DB-plan out ̄ows. Secondly the portfolio may experience runs of losses that can't be overcome by waiting for a better year because the money runs out. The general result is that higher stock allocations allow the higher earning potential of stocks, even if the losses are occasionally experienced, to accumulate enough wealth to see a DC portfolio match the promised bene®ts of a DB-plan. Copyright 2001 Published by Elsevier Science Inc.