Towers Watson has been comparing investment rates of return in defined benefit (DB) and defined contribution (DC) plans for more than 10 years.

1 This analysis updates our prior studies with investment returns for 20082for a large set of plans and provides a snapshot of year-end returns for 2009 based on a small set of plan sponsors.

In 2006 and 2007, DB plans outperformed DC plans by an average of about 1 percentage point per year based on asset-weighted returns. Earlier studies also found that, over time, DB plans attained higher returns than DC plans. In 2008, DB plans outperformed DC plans by roughly 2.7 percentage points, with aggregate returns negative for both plan types. The most recent comparably large margin in returns was during the last bear market (2000-2002), when DB plans outperformed DC plans by approximately 2.25 % annually. Our current analysis of year-end 2009 data — albeit drawn from a small sample — finds a reversal in median returns. Although both plan types performed well, DC plans outperformed DB plans by more than 60 basis points.

DB plans have been earning higher returns than their DC counterparts since 1999. This pattern continued through the financial meltdown of 2008, as DB plans had lower equity concentrations than DC plans, and so suffered a less severe hit. In 2009, however, the higher equity allocations of DC plans paid off as equity markets realized large gains (e.g., over 2009, the Russell 3000 Index had a 28% increase).

Like our earlier studies, this analysis is based on Form 5500 financial and pension disclosure data through 2008 released by the Department of Labor. Results for 2009 are based on Form 5500 information for 97 large plan sponsors from the Towers Watson 100 list of largest pension sponsors based on total obligations. 3 We also use the same formula as in earlier studies to calculate the average rate of return:

Rate of Return =
(2 * investment income)
(beginning balance assets + ending balance assets) – investment income

Our previous analyses focused strictly on investment income performance alone. Investment income is often reported net of investment expenses; this is especially true for mutual funds, common/collective and master trusts. For other plan investments, however, expenses are instead reported explicitly and separately in the Schedule H disclosures of Form 5500. To more accurately compare investment performance, giving due weight to implicit and explicit expenses, we subtract explicit investment costs from the income components for all years in the analysis. This reduces the overall difference in returns between DB and DC plans from prior analyses, on average, by roughly 20 basis points.

Comparison for sponsors of both plan types, 1995-2008

We initially include only employers that sponsored one DB plan and one DC plan, each with at least 100 participants. We limit our analysis to these plan sponsors to minimize the effects on the results of specific employer or workforce characteristics uniquely associated with the sponsorship of only one plan type. This approach enables us to concentrate on differences in rates of return more directly associated with retirement plan type.

Plan size still makes a difference

As in prior studies, we measure median rates of return weighted by plan asset size. The weighted basis is more relevant to understanding the experience of plan participants because, after all, plans with more assets generally have more participants. Figures 1a and 1b compare rates of return in DB and DC plans from 1995 to 2008, weighted by plan asset size.

Figure 1a. Asset-weighted median rates of return for DB and DC plans, 1995-2008

Source: Towers Watson.

Figure 1b. Asset-weighted median rates of return for DB and DC plans, 1995-2008

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Source: Towers Watson.

As seen in Figures 1a and 1b, 2008 was the worst year for both DB and DC plan returns over the period, brought on by tumbling equity markets. Nevertheless, when measured by the asset-weighted median, DB plans again outperformed DC plans in 2008, by about 2.7 percentage points. Interestingly, the last time DB plans outperformed DC plans by similarly large margins was during the 2000-2002 bear market; the percentage-point differences were 2.60 in 2000, 2.05 in 2001 and 2.08 in 2002.

During the analysis period (1995-2008), on average, both plan types performed better on an asset-weighted basis than on a plan-weighted basis (discussed below). Historically, larger plans outperform smaller plans because they have access to a wider variety of investment options, economies of scale and more investment expertise. In 2008, however, plan-weighted results were better for DB plans.

In Figure 2, we compare rates of return for the largest one-sixth, largest one-half and smallest one-sixth of the plans (based on assets in the DB plan to control roughly for the size of the plan sponsor) from 1995 to 2008.

Figure 2. Comparison of plan-weighted median returns by plan size, 1995-2008

Source: Towers Watson.

Over the entire period, among the largest plans — the top sixth or top half — DB plans outperformed DC plans by 1.27 and .75 percentage points, respectively. For the smallest one-sixth, however, the advantage reverses, as DC plans outperformed DB plans. Looking within plan type, larger plans outperformed smaller plans over the 1995-2008 period.

By contrast, in 2008, larger DB plans underperformed smaller plans by 1.25 percentage points, while large DC plans outperformed smaller ones by the same difference. Among large plan sponsors, DB plans outperformed DC plans by 2.60 percentage points, a moderately higher margin than in the prior years' bull markets but similar to results over the last bear cycle. Among small plans, DB plans outperformed DC plans by an even greater margin of roughly 5 percentage points in 2008.

A look at investment returns with all plans weighted equally

As in previous studies, we also look at investment returns giving all plans equal weight. Returns for 1995 to 2008 are shown in Figure 3.

Figure 3. Plan-weighted median rates of return for DB and DC plans, 1995-2008

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Source: Towers Watson.

After stronger performances by DB plans during the 2000-2002 bear market, DC plans outperformed DB plans from 2003 through 2007, as measured by plan-level medians. In 2008, DB plans edged ahead by approximately 4 percentage points. From 1995 to 2008, which captures both bull and bear markets, DB plans outperformed DC plans by an average of 35 basis points.

Over time, DC plans have a wider distribution of returns than DB plans. Figure 4 shows the standard deviation of returns from 1995 to 2008 for both plan types. The standard deviation measures how closely the observations cluster around the mean in a data set. With the exceptions of 2002, 2003 and now 2008, DC plans had a wider distribution of investment returns. This is not surprising — DC plans are self-managed by thousands of individual participants with varying financial skills choosing their asset allocations, while DB plans have more consistent investment strategies and performance, across plans and time. In 2008, however, the standard deviation was higher for DB plans than for DC plans. A possible explanation is that DB plans are using more diverse asset allocations (e.g., all fixed income), which led to some positive returns within the 2008 distribution.

Figure 4. Standard deviation of returns across plans, 1995-2008

Source: Towers Watson.

Effect of plan expenses on rates of return

The earlier analysis in this report looked at investment returns based on income performance, with investment expenses deducted. DB plans typically report income net of investment expenses. Expenses for DC plans, especially those invested in mutual funds, include administrative costs, and are typically deducted from investment returns. As a result, Form 5500 data do not reflect differences in returns for DB and DC plans arising from embedded non-investment costs in the investment income component. This is particularly true for mutual fund investments. In 2009, 45% of DC plan assets were invested in mutual funds, compared with only 14% of DB plan assets. 4

In DC plans, mutual funds had an average weighted expense of approximately 69 basis points in 2009. 5 With 45% of DC plan assets invested in mutual funds, a reasonable assumption is that these fees reduce rates of return by roughly 31 basis points. According to Towers Watson's DC fee data, roughly one-third of mutual fund fees are actually bundled administrative costs. So DC returns lose an average of 10 basis points due to bundled administrative costs incorporated into investment fees.

Between 1995 and 2008, asset-weighted median returns were 1.03% higher in DB plans than in DC plans. To make it an apples-to-apples comparison, we add 10 basis points to DC plan returns for implicit bundled administrative costs. This results in a net difference of an estimated 93 basis points.

Hypothetical case — Real-dollar effects of differential rates of return

To take this analysis further, we simulate the growth since 1995 of two hypothetical plans — one DB and one DC in real dollar terms using the asset-weighted returns, as shown in Figure 5.

Figure 5. Growth of hypothetical balance through asset-weighted median returns net of expenses

Source: Towers Watson.

Company X had $100 million each in DB and 401(k) assets at the end of 1994. We assume these plans have the same inflows and outflows, so growth is based strictly on investment performance. The balances of both plans remained fairly even through 1999, but starting in 2000, DB assets began to pull ahead. By year-end 2008, Company X's DB plan held $249 million in assets, while its DC plan had only $215 million — a difference of nearly $34 million or 14%. Over a period of 20 to 30 years, such differences become even more significant.

Percentage of equity affects rates of return, especially over 2008-2009

On the basis of asset-weighted medians, DB plans consistently outperformed DC plans during the 2003-2007 bull market as well as the recent bear market through 2008. But during the last half of the 1995-1999 bull market, DC plans outperformed DB plans. This reversal could be due to differences in equity allocations.

As shown in Figure 6, from 1995 through 1999, DC accounts had higher and growing allocations of equity compared with DB plans, so they reaped the rewards of high returns when the market was up. Even so, the difference in returns was less pronounced than one would expect, which might be because DB plan fund managers employed greater diversification or more sophisticated investment techniques.

This advantage to professional investing was particularly striking during the 2000-2002 bear market. Despite having similar or even higher allocations to equities than DC plans, DB plans outperformed DC plans during this period. Many DC plan participants seem to have bought high and sold low in the stock market. Some also might have been heavily invested in their employers' company stock, and, when the bubble burst at the beginning of this decade, their returns fell accordingly.

Allocations to equity for DC plans and DB plans also changed dramatically in 2007 and 2008, with DC plans again having larger allocations to equity. Allocations to equity for DB plans were highest in 2006, and DB sponsors started reducing their equity allocations when equity markets peaked near year-end 2007. During this period, DC allocations in equity surpassed DB allocations, possibly as DC participants failed to rebalance their portfolios.

By the end of 2008, a stark contrast had emerged between equity allocations in the two types of retirement programs. While assets declined in both plan types due to heavy losses in the stock market, DB plan sponsors benefited from their head start in switching allocations away from equities in 2007 and most likely continued to shift their portfolios during 2008.

The difference in asset allocations became more pronounced in 2009. While DB sponsors decreased their equity holdings to around 50% of the portfolio, DC investors apparently once again failed to rebalance their portfolios, as their equity allocations ballooned to approximately 65% — higher than in 2008 but below their 2007 levels. The higher allocations to equity worked in favor of DC participants in 2009 as their returns (discussed below) received a boost from strong market returns.

Figure 6. Equity share and rate-of-return difference for DB versus DC plans

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Source: Towers Watson tabulations of Form 5500 data, U.S. Board of Governors of the Federal Reserve System, Flow of Funds data (2010) and Investment Company Institute data (2009).

A snapshot of 2009 results

Last year's snapshot data provided a preliminary look at how retirement plans weathered the financial crisis. For 2009, the data are equally interesting, as they give us a glimpse of the investment performance of both plan types one year later and, in particular, of returns from a strong bull market following record-setting losses. We obtained data for 97 plan sponsors of the Towers Watson 100 (100 largest pension sponsors based on total obligations). In this smaller sample, DB plan assets had an average value of $6.5 billion, and DC plan assets had an average value of $4.9 billion — these are all large plans.

Our analysis of plan-weighted medians in the smaller sample found a 60-basis-point advantage for DC plans in 2009. DB plans realized median returns of 18.50% compared with 19.11% for DC plans. Measured by a simple mean, DC plans outperformed DB plans by 1.3 percentage points (19.99% versus 18.67%). A distribution of returns is shown in Figure 7.

Figure 7. Distribution of investment returns for DB and DC plans of the Towers Watson 100, 2009

Source: Towers Watson.

With their lower equity allocations following the recent financial crisis, it's not surprising that DB plans underperformed DC plans during a strong bull market. While fixed-income instruments realized very strong performances over 2009 and potentially hedged some of the losses in 2008 for DB plans (as DB plans have higher allocations in debt instruments), the gains were surpassed by the very strong equity returns. For example, over 2009, returns were 28% for the Russell 3000 Index and 17% for Barclays Capital Long Credit Index.

As shown in Figure 7, returns were higher than 15% for roughly 85% of DC plans versus 72% of DB plans. Over 2009, two DC plans had returns of more than 40%, which in both cases were attributed to very large gains in their company stock. Furthermore, about 56% of plan sponsors achieved higher returns in their DC plans than in their DB plans. The correlation between high equity allocations for DC plan participants and strong market returns suggests the analysis of the complete 2009 database later this year will yield similar results.


The results of our current comparison of investment returns are generally in line with past studies: During a bear market, DB plans outperformed their DC counterparts by roughly 2.5 percentage points. In terms of asset-weighted medians, which we feel best represent overall participant experience, DB plans continuously outperformed DC plans over the recent bull-to-bear cycle (2000-2008).

In terms of plan-weighted medians, DB plans outperformed DC plans in 2008 as well. The results are different for plan-weighted returns than for asset-weighted returns over the recent bull-to-bear cycle. By both measures, DB plans outperformed DC plans during bear markets (2000-2002 and 2008), but on a plan-weighted basis, DC plans outperformed DB plans when the market was booming (2003-2007).

In the 2009 bull market, among the small subset of plan sponsors we analyzed, DC plans seem to have outperformed their DB counterparts. While our sample is small, DC plans' larger allocations to equity at year-end 2009 suggest one reason for their better investment performance. Being less likely to have rebalanced their portfolios, DC plan participants were better situated to reap the rewards of the recent market boom — the same investing behavior that left them so vulnerable to drastic market declines in 2008. Meanwhile, many DB sponsors had already shifted toward more conservative investment strategies, which mitigated their 2008 losses, as demonstrated by a few DB plans that realized positive or only slightly negative investment returns.

DB plan sponsors have direct interest in investment performance. They or the professionals they hire usually have considerable financial education, experience and access to sophisticated investment tools — advantages DC plan participants typically lack. Plan sponsors and retirement regulators have implemented practices to help bridge the knowledge gap between institutional investors and DC participants. Default funds, typically life-cycle/target-date funds, are just one example. These new default investment options should encourage more sophisticated investment allocations and periodic rebalancing. These mechanisms are still fairly new, and it will take time to ascertain whether these tools can narrow the gap between DB and DC investment returns.


  1. Earlier analyses appear in "Investment Returns: Defined Benefit Versus 401(k)," Watson Wyatt Insider, June 1998; "Defined Benefit vs. 401(k) Returns: The Surprising Results," Watson Wyatt Insider, January 2002; "Defined Benefit vs. 401(k) Returns: An Updated Analysis," Watson Wyatt Insider, September 2003; "Defined Benefit vs. 401(k): The Returns for 2000-2002," Watson Wyatt Insider, October 2004; "Defined Benefit vs. 401(k) Plans: Investment Returns for 2003-2006," Watson Wyatt Insider, July 2008; "Defined Benefit vs. 401(K) Investment Returns: The 2006-2008 Update," Insider, January 2010.
  2. In our prior analysis, the 2008 results were based on a small snapshot of returns; here, they are based on a complete and final database.
  3. For more information about the Towers Watson 100, please see "TW Pension 100: 2009 Disclosures of Funding, Discount Rates, Asset Allocations and Contributions," Insider, April 2010.
  4. U.S. Board of Governors of the Federal Reserve System, Flow of Funds data (2010).
  5. Investment Company Institute, "The Economics of Providing 401(k) Plans: Service Fees and Expenses, 2009" ( Research Fundamentals, September 2010).