An Investment Strategy for Defined Benefit Plans

Defined-benefit plan sponsors typically select an asset allocation by undertaking a mean/variance analysis of the probability distributions of future rates of return. Unfortunately, next year's return on plan assets often has a minor impact on future sponsor contributions, hence a minor impact on the sponsor's future wealth. A sponsor can meaningfully evaluate the true risks and rewards of an investment strategy only by focusing on what they imply about the sponsor's future contributions. Actual plan sponsor data illustrate how a sponsor can select an asset allocation on the basis of future contributions and how misleading a mean/variance analysis of returns can be.