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.