and risk aversion; de Palma and Prigent (2008, 2009). In addition, individuals change pension funds based on performance (not short term returns), thus the pension fund managers with superior performance tend to grow in comparison with those which underperform. Thus, the market is regulated and portfolio allocations move toward optimal allocations. This (surrealistic) framework assumes that pension contributors know their optimal investment strategy and that pension fund managers then only have to offer these investment strategies so that the contributors may then select the investment options.

12. Empirical evidence, however, has made it clear that these assumptions are not valid, and therefore it becomes necessary to design pension systems based on more realistic assumptions. This will require assuming that contributors do not have a solid foundation to select a pension fund; the investment options are limited; and pension fund managers have strong incentives to maximize short-term returns.

13. In mandatory pension fund plans, people typically choose pension funds strongly encouraged by the sales force. According to Marinovic and Valdes (2005), the main variable explaining the choice of a pension fund management company is a visit by a sales agent. Berstein and Cabrita (2007) also corroborate this finding, but they claim that returns, coupled with a visit from a sales agent, offer a strong fuller explanation. This means that short-term returns are a persuasive rationale to switch to a different pension fund management company. The work of Calderón et al. (2008), using data from Mexico, shows that people generally do not switch to their optimal alternatives.

14. The selection of a pension fund based on its attributes is not necessarily the most appropriate action. Although the cited literature finds clear evidence of price inelasticity, there is confusion by what is meant by the price for members. In particular, these studies take short-term past returns from pension funds to explain the decisions of individuals. However, theory indicates that these variables should not be the principal explanations for portfolio selection, since it is already well-known that past performance is not a good predictor of future returns, and that returns, by themselves, are also not good indicators of portfolio quality. Fund contributors should be more interested in understanding the risk and return profile —something that will allow them to obtain better pensions in the future.

15. Empirical studies suggest that the selection of an optimal portfolio that maximizes their future pension is a decision too complex for an average individual to make. Economic behavior literature shows that people have a limited capacity to understand phenomena associated with pension funds and the level of financial literacy of the average individual, even in the case of the United States, United Kingdom among other developed economies, is too low to be able to make a proper portfolio selection; Benartzi and Thaler (2007). Campbell (2006), in turn, shows that people with lower incomes and less education are more prone to suffer losses as a result of poor investment decisions.

16. Since low financial literacy may impose a heavy tax on lower income people, it is imperative for public policy design of pension schemes to consider this factor. The compulsory nature of the pension funds does not imply that individuals understand the products that are being offered. Therefore, default strategies should be offered to individuals in order to ensure that adequate pensions are paid in the future. Experience from countries with compulsory savings systems and with default options, like Sweden 6