As defined contribution (DC) pensions become increasingly dominant in private sector provision in the UK, more thought is going into how DC plans should operate.

One crucial issue for employers and DC pension providers is how to use finite resources to give the maximum benefit.

In particular, should a DC scheme try to educate its members on investment, or should it accept that the vast majority of members will use a default fund and concentrate on making that fund as good as possible?

It is an interesting choice. The idealists would go for investment education, in order to help members help themselves. But the realists would say ‘you won’t change the inertia and apathy of most scheme members, so you need a good default fund’.

After all, it is reckoned that 90% of scheme members end up in a default fund. Sometimes this is because they are offered too much choice and are paralysed by the possible investment permutations.

More often though, it is simply because most individuals have relatively little investment knowledge and are worried about making the wrong decision.

There is also an argument that scheme members should not need to be an investment expert.

After all, if you own a car, you don’t need to be a mechanic to be able to drive it. In the same way, some would argue that a DC pension scheme should be designed to deliver members to their destination without requiring them to become investment experts.

A recent survey of pension consultants and scheme managers found that 56% thought DC schemes should offer better default funds, twice as many as those who thought better investment education should be offered. And scheme managers were particularly likely to favour better default funds.

In the past, most default funds offered a life-styling approach, or an automatic switch from equities into bonds and cash as retirement neared.

But more sophisticated solutions are now being championed by some.

Diversified growth funds with an absolute return focus as seen as one way to produce equity-like returns with bond-like volatility.

Another option, which the national, low-cost personal accounts scheme could use from 2012, is target date funds. These invest with an end retirement date, for example 2025, in mind.

As DC plans become more important in the UK, finding the right approach for default funds looks like becoming the Holy Grail of pension planning.

But retirees and DC plan designers must hope it turns out easier to find than the mythical Grail itself.

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