What is the purpose of an asset smoothing method?

The purpose of an asset smoothing method is to stabilize contributions by reducing the effects of market volatility. This approach allows organizations to manage their funding requirements in a more predictable manner by avoiding drastic changes in contribution levels resulting from fluctuations in investment returns.

When markets experience significant ups and downs, the immediate impact on asset values can lead to substantial variances in contribution levels needed to maintain funding objectives for pension or benefit plans. Asset smoothing mitigates this by averaging the investment returns over a specific period, thus allowing contributions to remain relatively stable from year to year, which is beneficial for both the employer and employees in terms of financial planning and budgeting. By implementing this method, organizations can better align their long-term financial strategies and maintain a consistent approach to funding their obligations.