On the investment strategies in occupational pension plans

Abstract

Demographic changes increase the necessity to base the pension system more and more on the second and the third pillars, namely the occupational and private pension plans; this paper deals with Target Date Funds (TDFs), which are a typical investment opportunity for occupational pension planners. TDFs are usually identified with a decreasing fraction of wealth invested in equity (a so-called glide path) as retirement comes closer, i.e. wealth is invested more riskily the younger the saver is. We investigate whether this is actually optimal in the presence of non-tradable income risk in a stochastic volatility environment. The retirement planning procedure is formulated as a stochastic optimization problem. We find it is the (random) contributions that induce the optimal path exhibiting a glide path structure, both in the constant and stochastic volatility environment. Moreover, the initial wealth and the initial contribution made to a retirement account strongly influence the fraction of wealth invested in risky assets. The risk aversion of an individual mainly determines the shape of the glide path, while the ratio of the wealth and income influences the steepness of the glide path.