Simulations of Long-Term Returns and Replacement Rates in the Colombian Pension System

Abstract

This study is a theoretical exercise for Colombia that aims to simulate a variety of scenarios under a hypothetical scheme similar to the multi-funds currently in operation in Chile, Mexico and Peru. This has been done by modeling the future movement of asset prices that are considered to be representative of equity and fixed-income using the Monte Carlo method. After making the simulations we have constructed alternative investment portfolios according to the chosen combination of equity and fixed-income, and compared and assessed them in terms of their risk-return ratio. The study emphasizes the fundamental importance of adequate contribution densities for obtaining sufficient income for old age, and the relevance of high returns, with adequate risk limitation. Another of the study’s aims is to use the new multi-fund scheme defined for Colombia as a basis for the hypotheses of different scenarios projected to 2050. These will include the composition of members’ pension fund portfolios and changes in the scheme over time, taking as a reference the life-cycle scheme operated in Mexico, as well as other compositions and profiles that participants may decide to enter into in accordance with their choice and the limits set by regulations. The results of the work confirm what has been found in other studies on the subject for the Colombian economy: that the implementation of a multi-fund system will provide pension-fund members with efficient returns in the long term, with limited volatility over time.

JEL Classification: G23, J32