Naive Diversification Strategies in Defined Contribution Saving Plans

TLDR

Defined contribution saving plans are increasingly popular worldwide, shifting responsibility for asset allocation to individuals and raising concerns about their ability to make effective investment decisions. The study examines how individuals diversify their contributions within defined contribution plans. Investors often employ a simple 1/n strategy, allocating contributions evenly across available funds, and the share invested in stocks is strongly correlated with the proportion of stock funds offered in the plan. JEL classification: G11, G23, H55.

Abstract

There is a worldwide trend toward defined contribution saving plans and growing interest in privatized Social Security plans. In both environments, individuals are given some responsibility to make their own asset-allocation decisions, raising concerns about how well they do at this task. This paper investigates one aspect of the task, namely diversification. We show that some investors follow the “1/n strategy”: they divide their contributions evenly across the funds offered in the plan. Consistent with this naive notion of diversification, we find that the proportion invested in stocks depends strongly on the proportion of stock funds in the plan. (JEL G11, G23, H55)