Pension Portfolio Choice and Peer Envy

ABSTRACT I examine the effect of envy on the portfolio allocation of workers in a defined contribution (DC) pension plan. If a worker's DC plan performs better than his co-worker's, he may gloat; on the other hand, if his DC plan performs worse, he may feel envy. I model anticipated envy when workers make portfolio allocations, and find that in equilibrium, workers will mimic their co-worker's allocation to eliminate the disutility from envy. This portfolio allocation is riskier than that of a worker who does not exhibit envy. INTRODUCTION Over the last several decades, there has been a movement in retirement saving plans offered by employers from defined benefit (DB) to defined contribution (DC). In DB plans, the plan sponsor promises workers a specified annuity benefit for their retirement, is liable for such a promise, and is responsible for asset management of funds in the plan. DC plans allow employees to decide in which assets their retirement investment will be allocated. Investment choice, within a menu offered by the sponsor, and capital market risk are moved from the employer to the employee in this plan. The introduction of DC plans to retirement saving has been of great concern lately. Even though it is believed that longevity risk should be managed by individuals pre-retirement, the introduction of DC plans has also shifted investment risk to individuals, which is something they may not be able to manage well (Turner, 2006). Recent capital market volatility has affected the performance of many plan participants' portfolios, and therefore, it is important to understand how investors will make investment decisions as their behavior could significantly alter their retirement wealth. Additionally, investment behavior is significant as "the aggregate outcome of a cluster of nonpoachable decisions--such as insuring appropriately, planning for retirement ...--will be more heavily influenced by a behavioral component" (Zeckhauser, 1986, p. S444). For instance, Muermann, Mitchell, and Volkman (2006) find that if an individual experiences regret, then his portfolio allocation will be different than that of a worker concerned only with risk. It is possible that an individual could feel regret when comparing his DC pension plan performance with that of his co-worker. For example, a worker could regret his portfolio allocation decision if his own individually managed investments in his pension plan do not perform as well as those of his co-workers. Such regret I call here "envy." Alternatively, a worker may experience some sort of rejoicing with regard to his allocation decision, if his own DC performance is better than that of his co-worker. This type of rejoicing I call here "gloating." Workers may then anticipate the disutility from envy when making their portfolio allocation decisions. In this article, I model envy and concentrate on the effect that anticipated envy has on portfolio allocation within a worker's DC pension. I show that, in equilibrium, envious workers will choose the same allocation as that chosen by their co-worker to eliminate the disutility from envy. This portfolio is a riskier one than that chosen by a worker that does not exhibit envy. But what exactly is envy? Adam Smith defines it as "passion which views with malignant dislike the superiority of those who are really entitled to all the superiority they possess" (1790, p. 244). When a co-worker has more DC pension wealth and he or she deservedly has it, the envious worker will feel he could have had the same wealth had he chosen the same portfolio allocation. Envy is different from resentment, as resentment is concerned with seeing another's good fortune that is undeserved; envy is more concerned with others having something that is rightfully theirs but that an individual wants for himself (Ben Ze-ev, 1992). In this framework, envy is applicable to the DC pension portfolio allocation decision. Additionally, the DC pension setting seems appropriate to investigate envy because, unlike online brokerage houses where investors are anonymous, in a DC pension plan it is more evident who an investor might envy (i. …