An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk

by Allison Schrager

there is a good chance your retirement account is invested with a strategy called a target date fund. It mitigates the risk your portfolio will lose money as you age by taking your money out of stocks and investing it in short-term bonds; because short-term bond prices are fairly stable and predictable, your balance won’t fluctuate too much. This strategy offers some certainty about how much money you will have saved on the day you retire. But it does not offer any certainty about how much you can actually spend each year, because you can’t predict how long you will live or what the market will do to your savings during retirement. We can buy that certainty from an insurance company by purchasing a fixed, or simple life, annuity: you hand over your savings to an insurance company and it pays you a fixed amount* every year for as long as you and/or your partner live after you retire. This is as close to risk-free as retirement gets, delivering the goal of predictable income for every year you live, versus a lump amount saved up to day one of retirement that you still have to manage.