A comparison of state university defined benefit and defined contribution pension plans: a Monte Carlo simulation

This paper examines investment risk in comparing defined benefit (DB) and defined 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 first is that not enough is being earned by an allocation rule to cover DB-plan outflows. 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 benefits of a DB-plan.