I don't think the author knows. They say "to spend" which implies net, but other phraseology in the article indicates it's the total amount. You'd almost certainly have to pay taxes on it.
Other criticisms are mentioned elsewhere in the thread; overall a pretty sloppy and incoherent article.
Perhaps a frivolous comment, but I'd still rather take the $1M, and especially at 35. I'm a few years older and would still prefer the $1M now, even if it was clear this is my entire retirement contribution.
I'd back myself over the next 20 years to turn that $1M into something worth considerably more. If I made a mess of it, I'd still hopefully have enough productive years left to salvage the situation.
Whereas $5,000 per month is $5,000 per month forever. Unless you can live substantially under that amount and save a good chunk each month, you're never going to have capital to really grow.
Depends how you look at it. With the $5000/month you wouldn't have to work for money, so you could devote 100% of your time to whatever it was you wanted to start. Even if you needed capital, you should be able to get a loan relatively easily given your guaranteed 5k/month lifetime income.
You would think so, but you might be surprised. A couple years back I was looking to get a mortgage. I own a profitable company that pays me a comfortable 6-figure salary and has for years, as well as having liquid savings greater than the total value of the house I was buying. Most of the savings are in a holding company though, so it made sense to get a mortgage rather than taking the tax hit of withdrawing the funds. While I did eventually get a mortgage, it was actually quite difficult, because my income was not "guaranteed". One lender even said something along the lines of, "Yes, you have that money saved, but there's no guarantee you won't spend it." And somehow the fact that I owned the company paying my salary made that income less reliable than if I was dependent on a separate employer.
Even though by any logical metric I was far less of a risk than someone living paycheck to paycheck, the situation was outside of their regular mold, so they considered it risky.
Ill take that 5000K per month, move to cheap state and reinvest 1.5K every month at 7%/year (ill find a way). In 23 years (58yo) i will save another million + will have spent 1million at 3.5K/month.
If you already have some savings, the $5,000/mo guaranteed may make retirement feasible. Sure, eventually it'll be inflated to be worth less, but by then your other savings should have grown too. Also, Social Security kicks in at some point.
I recognized them the same, but $5,000 a month is $5,000 a month, even if the market tanks the first few years of retirement. My retirement strategy will use SOME annuities, but not all, though if I had to choose all or nothing, an annuity ensures I will NEVER be broke, I will always have $5,000/mo. Old and broke is a combination I don't want to try. Read Tony Robbins "Money"
Even an annuity is not guaranteed; the issuing company could go out of business, or we could have rampant inflation that wipes out the value.
Of course, those things might have a very low probability of happening, but there is also a low probability of a well-diversified portfolio from being wiped out.
> if I had to choose all or nothing, an annuity ensures I will NEVER be broke, I will always have $5,000/mo
$1 million is 16⅔ years of $5,000 a month. The cumulative rate of inflation since 2000 has been -29% [1]. That $5,000 would buy today what $3,500 bought then.
Also, keep in mind that someone is paying you that $5,000 a month. They could go bankrupt one month into their obligation to you. Inflation risk, foreign exchange risk, counterparty risk and tax consequences are just some of the risks one would need to consider when weighing lump sums versus annuities.
I would take the $5000/month, because $1M is only $3333/month according to the 4% safe withdrawal rule. Where do they get these annuity equivalent number referenced in the article, anyway?
I might make a different choice if it was between the two amounts with no strings attached (i.e not necessarily for retirement), so I could invest a bit more aggressively and keep working.
It's also nonsense because it doesn't factor in the fact that if you live past 81, the 5k a month is worth more even ignoring the safe withdrawal rule.
A pretty poorly constructed example for WSJ I think
Is it really? Consider even one medical event, likelihood of which is high... Unless you have a sterling medical coverage you might get into medical debt or be unable to perform procedures.
In the US, acute events are usually covered by Medicare.
Your risk in that scenario is long term care needs. That will drain your savings until you're poor enough to move to Medicaid. Another good reason to take the $5,000
A life annuity is one where up front you pay $X, and for the rest of your life you get $Y at regular intervals. They're comparing what someone would pay out on a $1,000,000 life annuity.
This is different than the 4% safe withdrawal idea because you're drawing from the principal all the time not just the interest.
Companies offer this because they expect you to die long before the principal runs out and then they get to keep what's left of it. Or, maybe you live longer than that and they have to pay more than what the initial investment earned them.
There are two guaranteed downsides to annuities: 1) they generally fall into the "insurance" category, and as we know insurance companies can get in trouble and even go under, and 2) there is a 0% chance that your annuity will outlive you. If you had $1M and withdrew roughly 4% for the rest of your life, there's a decent chance it would be worth MORE than a $1M when all is said and done. The annuity takes advantage of that fact.
Like other forms of insurance, they're probably going to make money on you. Unlike health/car insurance, this type isn't legally required or usually a good idea.
1) In Canada, annuities are covered by Assuris, so that's not a concern. I imagine that Europe has similar protections.
2) Is balanced by the upside risk that I live to 117 and run out of money. And frankly, I'm much more worried about that than I am about stiffing my heirs (at least once college is paid for).
3) If you had $1M and withdrew roughly 4% for the rest of your life, there's also a decent chance it would be worth a lot less than $1M when all is said and done and you're eating capital. Remember, you're no longer a long term investor, you can't ride out ups and downs, you have to keep paying the bills during down periods, excaberating your losses.
I'm firmly of the belief that annuities are one of the best types of insurance you can buy.
> Remember, you're no longer a long term investor, you can't ride out ups and downs, you have to keep paying the bills during down periods, excaberating your losses
I don't know about you, but most people in my social circle intend to retire between 55-60 and that leaves 25-30 years of retirement, so definitely still in the long term investing range.
When I retire, I don't plan to adjust my investments until I get past 80.
Doesn't matter what you call it, if you're withdrawing money every month your portfolio should be mostly bonds.
Model it yourself, calculate what a 30% drop in the stock market next year would do to your portfolio. If you're a long term investor, an 80/20 stock/bond split makes sense.
But if you regularly withdraw 4% of original capital inflation adjusted, a model that incorporates the possibility of a 30% drop will show you why you need more bonds.
And show you why 4% is unrealistic and why a 5% annuity is a good deal.
The company might make a lot of money off you. But, they might lose a lot of money if you live too long. The risk is transferred from you to them, and you live with a specific fixed income for the rest of your life, however long that may be.
You don't worry about the economy going up and down or interest rates rising and falling. You don't worry about living too long and running out of money. You don't worry about living too little, and dying with most of your money still in the bank. You stop worrying about the future.
Sure, the math may add up to "that company is making a bit of money that you might have made", but when I retire I want to not give a shit about the future anymore. That's why it's a good deal, to some people.
You do worry about economy as a big crash might wipe out whoever is paying out the annuity.
You can probably also spend more windfall given 1M investment rather than 5k. With the annuity, you would be smart to reinvest any excess, but you also cannot overdraw if needed, e.g. for medical reasons. You would have to go for debt and lose money.
I plan to buy an annuity at 80 years old, if I make it that far.
My actuarial life at that point can't be very long, so it shouldn't be too expensive. It's a good way to manage tail risk in case I do live to 100+, and will allow me to spend the rest of my capital more freely knowing my base expenses are covered for life between the anuity and social security.
I was thinking the opposite - the safe withdrawal rate accounts for a 3% inflation rate for your 7% safe investment figure, so your nest egg grows over time for the same equivalent $3,333 in perpetuity no matter the year.
The $5,000 would get progressively worse over time.
You chose the wrong one. No matter what the article says, the $1M is more valuable. First, the safe withdrawal method of 4% is actually not safe - the safest method of withdrawal is called variable percentage withdrawal and not only takes into account the principle, but also the results year after year.
But more importantly, $1M lump vs $5,000 monthly annuity, always take $1M. Why? Because you are taking an asset class that can be converted into shares/bonds which has a higher expected returns than an annuity because it can compound.
What I mean is while the $5,000 annuity is guaranteed, it will remaing $5,000 year-over-year, which means it's actually decreasing in purchasing power year-over-year (unless there is deflation, which it's very unlikely). Wereas the $1M cash, if moved to bonds and shares, even if it performed at 5% annually, it will mean on the first year break even, but on the second year it will compound (unless you spend all the money). You could say you invest the monthly savings from the $5,000 but simply put it, $1M in shares has a much higher expected return than $5,000 monthly in perpetuity.
There are a ton of flaws in this comment, and I don't understand why it's at the top of this chain.
"First, the safe withdrawal method of 4% is actually not safe - the safest method of withdrawal is called variable percentage withdrawal and not only takes into account the principle, but also the results year after year."
This is an argument for taking the annuity. When two options have the same expected value, volatility is a bad thing.
"Because you are taking an asset class that can be converted into shares/bonds which has a higher expected returns than an annuity because it can compound."
The author writes under the pretense that the $5K figure is EQUAL to the risk-adjusted rate of return on a $1M principal. Sure, there are asset classes that have higher expected returns than a guaranteed annuity, but that is because they are RISKIER. Obviously, people value risk differently, which is why in general, you can't say "always take $1M"
"Whereas the $1M cash, if moved to bonds and shares, even if it performed at 5% annually, it will mean on the first year break even, but on the second year it will compound (unless you spend all the money)."
The whole point of the $5K figure is that it is the same amount as the risk-adjusted return on a $1M investment. How the user chooses to spend that $5K monthly sum is up to them and they have the freedom to spend or invest that sum in the same manner regardless of which option he/she takes.
"You could say you invest the monthly savings from the $5,000 but simply put it, $1M in shares has a much higher expected return than $5,000 monthly in perpetuity."
Incorrect for the above reasons.
Assuming that $5K/month annuity is the expected rate of return on a $1M invested in a risk-free asset class (which is the assumption this article is written on) and you have the option to cancel the annuity and retrieve your principal at any time, it's pretty clear that the annuity is the better option because it has NO volatility.
The reality is that an annuity comes with lower volitility and risk.
When you look at the risks for a retirement payout, you need to think carefully. How long will you live? How long will you retain your faculties to manageme investments? What protections do you have against dishonest or incompetent advisors?
Unless you're unlikely to live long, or have trustworthy children or other advisors, the annuity is probably the best scenario.
No assumption here. The expected return of an asset class like shares and bonds is higher than the annuity, which is always $60,000 and nothing more - this is a fact.
But as you said just because the expected is higher doesnt mean the actual will be. But you still should always pick whatever has higher expected
We don't usually think about absolute return as much as we do return conditioned on an acceptable level of risk.
You can almost think of risk as currency, i.e. each addition unit of risk opens you to strategies with higher expected return. But you can also access strategies for which you're able to "pay" the risk (basically fits into your tolerances).
You're missing the problem of sequencing of returns. If you made that decision at 65 years old in December of 2007, you would quickly regret it unless you were one of the small percentage of people who can take the massive volatility that followed over the next 15 months.
You ABSOLUTELY MUST take into account the risk. Not doing so would get your sued as a financial planner. Frankly, this is where people lose so much of their savings is listening to hogwash like this.
Go spend some time and get your CFP or CIMA certification and then come back, and your answer will have changed.
And if I sound ticked off, it's be cause I am. you are totally ignoring Behavioral Finance, which is much, much more important than simple math.
No assumption here. The expected return of an asset class like shares and bonds is higher than the annuity, which is always $60,000 and nothing more - this is a fact.
But as you said just because the expected is higher doesnt mean the actual will be. But you still should always pick whatever has higher expected
In Europe you can get above 10% before tax with "peer to peer" lending at https://www.twino.eu. The company guarantees it and their financials looks healthy, but there is a risk of them being a scam or defaulting.
Personally, I would take your money for a guaranteed 5% and invest it in more risky funds, covering the losses or taking the excess gains.
> Because you are taking an asset class that can be converted into shares/bonds which has a higher expected returns than an annuity because it can compound.
The annuity can compound too, if you treat it like you would any other 6% dividend and reinvest it.
Once you see that, the two become almost functionally equivalent. It comes down to a liquid million dollars with market returns or an illiquid million dollars with a guaranteed 6% return.
Which is better comes down to luck. If its 2006 and stocks are at all-time highs, then the 5% guaranteed will definitely return more over 10 years, and maybe over 20 and 30 years. If it's 2009 and stocks have cratered, the liquid million in the market wins handily.
The liquid million has a slight edge in expected value, as 7% > 6%. But when you consider the 6% is a lower bound and the 7% is an average, it becomes clear that there are situations where the guaranteed income stream could win.
I think I've lived too hard in my youth to make $1m via the $5k a month count before I kick it. Plus I'm a gambler so I'd take the $1m up front, considering my bet is that I'll die before I collect.
Strange how you are suffering from an illusion either way. From quoted annuity prices I've seen the $5000 is actually worth a bit more than $1MM in net present value.
I know a cop in south florida who's is getting 5800 a month pension after 20 years of service with health insurance included. Not bad if you start working at say 25 after a few years in the service.
The packages some of these municipal employee's get for retirement are amazing.
$1M buys a lot of (mostly) safe dividend paying stocks, bonds, and real estate. $5k/month worth, net? Perhaps not, but certainly one could position himself better than $5k/mo on an annuity with a fairly small effort or higher risk tolerance.
Annuities have an advantage because it effectively transfers wealth from people who die early to people who live longer. If you're only around to enjoy the annuity for a decade, you overpaid for the income stream. If you're around for five, you've underpaid.
It's a vaguely similar advantage to taking out a reverse mortgage.
Yes, I understand that, but my point is that there are better investments than an annuity, so the "$1M or $5k/mo" comparison falls a little flat. The aren't really the same.
Of course there are - that's why people offer annuities. Other investment options don't let you consume other people's inheritances when you live longer than them, though.
Before reading the article I just calculated that they would probably be similar, I would probably be inclined to take the monthly $5K because I don't have as much faith in the market delivering 6% returns over the long term.
However; there are so many factors that could push me to decide that $1M would be better.
I don't think it would help me personally to see a Monthly projections on my retirement accounts. In fact, I trust monthly projects less because I've seen my 401K projecting a huge per month number when I was contributing a miserly amount of my pay check. I wonder whether they were straight up lying or assuming my salary and contributions would increase.
The thing about projections is that there are so many factors that the investment companies don't know about me or my plans. They don't know when I'm planning to retire, what my budget is, what other investments I have, what I expect to make in the future, or what risks I'm planning for.
If people have as much information as there exists today and they make bad decisions, changing it to monthly projections won't solve their problems. It might create more.
> don't have as much faith in the market delivering 6% returns over the long term
A 6% return is not equivalent, because a 6% return would still leave you with $1m at the end of the day (or your life). An equivalent return for a 25 year period would be about 4%, and I defy you to find a diversified portfolio that can't return 4% over 25 years...
I would take the $1M: with that money you can reinvest part of it in a diversified portfolio and in the real state market having money and an income.
Also due to inflation $5000 today might be worthless in 10 years, so it would take more than 16 years to get the same ammount of cash. Considering you retire at ~65 would be one more reason in favoring the $1M.
Historically speaking, income streams are worth 20 to 25 times their annual payment. Like, there's examples of this ratio from France in the 1400s, IIRC. So $5k/mo = $60k/y = $1200k. Granted, this doesn't take into account how annuities generally don't pay to a recipient's heirs, so there's an actuarial table discount to take the ratio down.
It depends on how good you are at investing. For example, if Warren Buffett was starting over again, he would probably make better use of the $1 million.
I'd take the $mil and develop some of the productive ideas i have, not worrying so much if they don't quite deliver.
Also, I had a dream when I was younger that I'll die when I'm 73 and my lifestyle generally points to the sense in not assuming too many years beyond retirement age, which here in Blighty might hit 70 by when my time comes around.
- ed
I'm not 40 yet, so waiting for literal decades before some speculative pay off seems like too hard-headed a form of sense to fit my character!
Somewhat similar thought experiment I like to ask: if you could have either a guaranteed $1M or a random amount between 0 and $5M, which would you choose (and why)?
Then, what would the high end of the second range need to be to get you to change your mind (assuming the low end is fixed at zero)?
I'm not in need of that much money, so the 1 million guarantee is not valuable enough to me to offset the fact that I would have 50%+ chance of getting something more than 2.5 million.
high end of $2,100,000 on the second case is enough for me to switch to the second one.
That's what you would expect, yes. What has surprised me so far is how weighted the responses I've received are toward the guaranteed 1M, even among people with plenty of money.
I guess another interesting question instead of adjusting the range of the random outcome would be to scale the whole thing. Say you'd take the million. What about 10k vs 0-50k? My expectation is that the responses would be more consistent (ie less dependent on size relative to net worth) than you'd think.
5k month does not pose risks about having the 1M somewhere and potentially having to invest it in order to avoid losing ability to buy things for the money. Moreover you can't do a silly thing with 5k/m while you can do plenty with 1M. It's interesting to note that it's easy to turn 1M into 5k month btw, by purchasing a a few houses in strategic places, while the contrary is a bit more complex.
Yes sure, I'm reasoning in Italian terms where the retirement is always handled by the government, so for you not getting the retirement at all the whole country must fail, which is not impossible in the case of Italy... but well, if it happens, you are likely to have issues anyway. To clarify, even if you work for a private company or you are a self-employed person, you give money every year in order to have your retirement. The money is provided directly to the government, that will later handle your retirement sending you monthly checks. So it does not matter what happens to your original company, IF you provided money during your work-life, you'll get the money back in form of "pension" check. Btw with this system, you cannot retire when you wish, there are age limits and number of years of work limits.
Do we need to throw into the discussion some more behavioral economics concepts like hyperbolic discounting and present bias and present versus future value of money?
I did not read thoroughly, but isn't the equivalence between 5k/month and $1mil only in terms of the amount you can take out each point to maintain your principal? Assuming that's the case, when you die you'd still have $1Mil in the lump sum scenario, as opposed to zero in the other....
1m of course... Especially in a country where healthcare can be expensive and I might need a large amount suddenly for a life-threatening health issue.
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[ 2.3 ms ] story [ 180 ms ] threadOther criticisms are mentioned elsewhere in the thread; overall a pretty sloppy and incoherent article.
I'd back myself over the next 20 years to turn that $1M into something worth considerably more. If I made a mess of it, I'd still hopefully have enough productive years left to salvage the situation.
Whereas $5,000 per month is $5,000 per month forever. Unless you can live substantially under that amount and save a good chunk each month, you're never going to have capital to really grow.
Even though by any logical metric I was far less of a risk than someone living paycheck to paycheck, the situation was outside of their regular mold, so they considered it risky.
Of course, those things might have a very low probability of happening, but there is also a low probability of a well-diversified portfolio from being wiped out.
$1 million is 16⅔ years of $5,000 a month. The cumulative rate of inflation since 2000 has been -29% [1]. That $5,000 would buy today what $3,500 bought then.
Also, keep in mind that someone is paying you that $5,000 a month. They could go bankrupt one month into their obligation to you. Inflation risk, foreign exchange risk, counterparty risk and tax consequences are just some of the risks one would need to consider when weighing lump sums versus annuities.
[1] http://www.usinflationcalculator.com
It is close enough.
1/(1-0.29)=1.4
Depends on if you are going back or forward in time.
plus if we consider inflation 1000 000 on day 1, worth a lot more than in 16 years
So I would say ... take the 1M
I might make a different choice if it was between the two amounts with no strings attached (i.e not necessarily for retirement), so I could invest a bit more aggressively and keep working.
A pretty poorly constructed example for WSJ I think
Your risk in that scenario is long term care needs. That will drain your savings until you're poor enough to move to Medicaid. Another good reason to take the $5,000
However, if your below 70 and in very good health the 5k/month is probably a much better bet.
A life annuity is one where up front you pay $X, and for the rest of your life you get $Y at regular intervals. They're comparing what someone would pay out on a $1,000,000 life annuity.
This is different than the 4% safe withdrawal idea because you're drawing from the principal all the time not just the interest.
Companies offer this because they expect you to die long before the principal runs out and then they get to keep what's left of it. Or, maybe you live longer than that and they have to pay more than what the initial investment earned them.
Like other forms of insurance, they're probably going to make money on you. Unlike health/car insurance, this type isn't legally required or usually a good idea.
2) Is balanced by the upside risk that I live to 117 and run out of money. And frankly, I'm much more worried about that than I am about stiffing my heirs (at least once college is paid for).
3) If you had $1M and withdrew roughly 4% for the rest of your life, there's also a decent chance it would be worth a lot less than $1M when all is said and done and you're eating capital. Remember, you're no longer a long term investor, you can't ride out ups and downs, you have to keep paying the bills during down periods, excaberating your losses.
I'm firmly of the belief that annuities are one of the best types of insurance you can buy.
I don't know about you, but most people in my social circle intend to retire between 55-60 and that leaves 25-30 years of retirement, so definitely still in the long term investing range.
When I retire, I don't plan to adjust my investments until I get past 80.
Model it yourself, calculate what a 30% drop in the stock market next year would do to your portfolio. If you're a long term investor, an 80/20 stock/bond split makes sense.
But if you regularly withdraw 4% of original capital inflation adjusted, a model that incorporates the possibility of a 30% drop will show you why you need more bonds.
And show you why 4% is unrealistic and why a 5% annuity is a good deal.
The company might make a lot of money off you. But, they might lose a lot of money if you live too long. The risk is transferred from you to them, and you live with a specific fixed income for the rest of your life, however long that may be.
You don't worry about the economy going up and down or interest rates rising and falling. You don't worry about living too long and running out of money. You don't worry about living too little, and dying with most of your money still in the bank. You stop worrying about the future.
Sure, the math may add up to "that company is making a bit of money that you might have made", but when I retire I want to not give a shit about the future anymore. That's why it's a good deal, to some people.
You can probably also spend more windfall given 1M investment rather than 5k. With the annuity, you would be smart to reinvest any excess, but you also cannot overdraw if needed, e.g. for medical reasons. You would have to go for debt and lose money.
My actuarial life at that point can't be very long, so it shouldn't be too expensive. It's a good way to manage tail risk in case I do live to 100+, and will allow me to spend the rest of my capital more freely knowing my base expenses are covered for life between the anuity and social security.
The $5,000 would get progressively worse over time.
But more importantly, $1M lump vs $5,000 monthly annuity, always take $1M. Why? Because you are taking an asset class that can be converted into shares/bonds which has a higher expected returns than an annuity because it can compound.
What I mean is while the $5,000 annuity is guaranteed, it will remaing $5,000 year-over-year, which means it's actually decreasing in purchasing power year-over-year (unless there is deflation, which it's very unlikely). Wereas the $1M cash, if moved to bonds and shares, even if it performed at 5% annually, it will mean on the first year break even, but on the second year it will compound (unless you spend all the money). You could say you invest the monthly savings from the $5,000 but simply put it, $1M in shares has a much higher expected return than $5,000 monthly in perpetuity.
Which is why it is smart to change the type of investment as you get closer to retirement.
In any case, whereas 5% might be conservative in the long run, you could be totally screwed in the short term in a bubble.
"First, the safe withdrawal method of 4% is actually not safe - the safest method of withdrawal is called variable percentage withdrawal and not only takes into account the principle, but also the results year after year."
This is an argument for taking the annuity. When two options have the same expected value, volatility is a bad thing.
"Because you are taking an asset class that can be converted into shares/bonds which has a higher expected returns than an annuity because it can compound."
The author writes under the pretense that the $5K figure is EQUAL to the risk-adjusted rate of return on a $1M principal. Sure, there are asset classes that have higher expected returns than a guaranteed annuity, but that is because they are RISKIER. Obviously, people value risk differently, which is why in general, you can't say "always take $1M"
"Whereas the $1M cash, if moved to bonds and shares, even if it performed at 5% annually, it will mean on the first year break even, but on the second year it will compound (unless you spend all the money)."
The whole point of the $5K figure is that it is the same amount as the risk-adjusted return on a $1M investment. How the user chooses to spend that $5K monthly sum is up to them and they have the freedom to spend or invest that sum in the same manner regardless of which option he/she takes.
"You could say you invest the monthly savings from the $5,000 but simply put it, $1M in shares has a much higher expected return than $5,000 monthly in perpetuity."
Incorrect for the above reasons.
Assuming that $5K/month annuity is the expected rate of return on a $1M invested in a risk-free asset class (which is the assumption this article is written on) and you have the option to cancel the annuity and retrieve your principal at any time, it's pretty clear that the annuity is the better option because it has NO volatility.
The reality is that an annuity comes with lower volitility and risk.
When you look at the risks for a retirement payout, you need to think carefully. How long will you live? How long will you retain your faculties to manageme investments? What protections do you have against dishonest or incompetent advisors?
Unless you're unlikely to live long, or have trustworthy children or other advisors, the annuity is probably the best scenario.
But as you said just because the expected is higher doesnt mean the actual will be. But you still should always pick whatever has higher expected
You can almost think of risk as currency, i.e. each addition unit of risk opens you to strategies with higher expected return. But you can also access strategies for which you're able to "pay" the risk (basically fits into your tolerances).
You're missing the problem of sequencing of returns. If you made that decision at 65 years old in December of 2007, you would quickly regret it unless you were one of the small percentage of people who can take the massive volatility that followed over the next 15 months.
You ABSOLUTELY MUST take into account the risk. Not doing so would get your sued as a financial planner. Frankly, this is where people lose so much of their savings is listening to hogwash like this.
Go spend some time and get your CFP or CIMA certification and then come back, and your answer will have changed.
And if I sound ticked off, it's be cause I am. you are totally ignoring Behavioral Finance, which is much, much more important than simple math.
But as you said just because the expected is higher doesnt mean the actual will be. But you still should always pick whatever has higher expected
Personally, I would take your money for a guaranteed 5% and invest it in more risky funds, covering the losses or taking the excess gains.
The annuity can compound too, if you treat it like you would any other 6% dividend and reinvest it.
Once you see that, the two become almost functionally equivalent. It comes down to a liquid million dollars with market returns or an illiquid million dollars with a guaranteed 6% return.
Which is better comes down to luck. If its 2006 and stocks are at all-time highs, then the 5% guaranteed will definitely return more over 10 years, and maybe over 20 and 30 years. If it's 2009 and stocks have cratered, the liquid million in the market wins handily.
The liquid million has a slight edge in expected value, as 7% > 6%. But when you consider the 6% is a lower bound and the 7% is an average, it becomes clear that there are situations where the guaranteed income stream could win.
Today, immediateannuities.com is quoting around $5300 for 65yr old woman and $5665 for a 65yr old man for a $1 mil purchase.
The packages some of these municipal employee's get for retirement are amazing.
It's a vaguely similar advantage to taking out a reverse mortgage.
However; there are so many factors that could push me to decide that $1M would be better.
I don't think it would help me personally to see a Monthly projections on my retirement accounts. In fact, I trust monthly projects less because I've seen my 401K projecting a huge per month number when I was contributing a miserly amount of my pay check. I wonder whether they were straight up lying or assuming my salary and contributions would increase.
The thing about projections is that there are so many factors that the investment companies don't know about me or my plans. They don't know when I'm planning to retire, what my budget is, what other investments I have, what I expect to make in the future, or what risks I'm planning for.
If people have as much information as there exists today and they make bad decisions, changing it to monthly projections won't solve their problems. It might create more.
A 6% return is not equivalent, because a 6% return would still leave you with $1m at the end of the day (or your life). An equivalent return for a 25 year period would be about 4%, and I defy you to find a diversified portfolio that can't return 4% over 25 years...
Also due to inflation $5000 today might be worthless in 10 years, so it would take more than 16 years to get the same ammount of cash. Considering you retire at ~65 would be one more reason in favoring the $1M.
Is that really still true nowadays?
I'll retire at 55 with a pretty good annuity payment. It's not zero risk, but pretty secure.
Also, I had a dream when I was younger that I'll die when I'm 73 and my lifestyle generally points to the sense in not assuming too many years beyond retirement age, which here in Blighty might hit 70 by when my time comes around.
- ed
I'm not 40 yet, so waiting for literal decades before some speculative pay off seems like too hard-headed a form of sense to fit my character!
Then, what would the high end of the second range need to be to get you to change your mind (assuming the low end is fixed at zero)?
I'm not in need of that much money, so the 1 million guarantee is not valuable enough to me to offset the fact that I would have 50%+ chance of getting something more than 2.5 million.
high end of $2,100,000 on the second case is enough for me to switch to the second one.
500K? 100K?
If you're already comfortable, the random amount has a better expected return.
I guess another interesting question instead of adjusting the range of the random outcome would be to scale the whole thing. Say you'd take the million. What about 10k vs 0-50k? My expectation is that the responses would be more consistent (ie less dependent on size relative to net worth) than you'd think.
I'm ok with this :-)
There are a lot of Dallas Firefighters and GM employees and many, many others that took that bet and it came up short.
Nobody is insulated from risk.