The Aleph Blog » Blog Archive » Bank Guarantees and Defined Contribution Plan Exchange Frequency

Bank Guarantees and Defined Contribution Plan Exchange Frequency

At his excellent blog, Paul Kedrosky posted a piece on bank deposit guarantees across nations.  It included this graph:

Now I will give you an unusual analogy that reflects the story that this graph is telling us.  This is somewhat like what the Defined Contribution [DC] plan industry went through when it moved from annual valuation, annual redirection of monies, to quarterly, to monthly, to the eventual change your asset allocation once a day if you like.

With annually, a huge number of people would make moves. Quarterly, not so much, but it still increased the over all number of transactions. Monthly brought a decline in the total number of transactions. Daily? Few people transact because they can always do it.

So, when the guarantee is unlimited, few take advantage of it. When it is limited, people get far closer to the limit on average.

This is just another application of behavioral economics.  When something is free, people don’t value it as much, so they don’t use it.  When something is hard to do and valuable, they take every opportunity.  In between they act to some degree to preserve value at the appropriate dates or amounts.  After all they will have another chance soon.






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One Response to Bank Guarantees and Defined Contribution Plan Exchange Frequency

  1. Ben Williams says:

    Interesting analogy to DC. I would add that the move to daily valuation was driven by competition among the providers and by demand from a tiny minority of squeaky wheels in the plans (some of whom fancied themselves great traders). Brokerage windows also came to satisfy the latter.

    It’s interesting that daily access reduces the usage, because it increased the costs, in several ways: the development of IT systems to support it, and the shift toward investment products with reduced “duration” (e.g., money market funds instead of stable value). It was a hassle to deal with equity wash rules to protect the stable value accounts from excess transactions.

    We joked in my business (providing investment advice to DC participants) that the average participant’s planning horizon equalled the reporting period.

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