The Use of Utility Functions for Investment Channel Choice in Defined Contribution Retirement Funds. II: A Proposed System

Abstract

ABSTRACTIn this paper a system for recommending investment channel choices to members of defined contribution retirement funds is proposed. The system is interactive, using a member's answers to a series of questions to derive a utility function. The observed values are interpolated by means of appropriate formulae to produce a smooth utility function over the whole positive range of benefits at retirement. The resulting function, together with stochastic models of the returns on the available channels and of the annuity factor at exit, is then used to recommend an optimum apportionment of the member's investment. The proposed system is applied to the observed values of utility functions of post-retirement income elicited from members of retirement funds. Difficulties in the application are discussed and the results are analysed. The sensitivity of the recommendations to the parameters of the stochastic model is discussed.