Annuities: buying an income you cannot outlive
An annuity is not an investment. It is insurance against outliving your money, and insurance is not supposed to be a good bet.
Judge it as insurance rather than comparing its 'return' to the stock market.
How Annuities: buying an income you cannot outlive works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
The basket is an average, and you are not average
If you rent in a city and drive to work, your personal inflation rate in a year of surging rents and fuel can be double the headline. The number is not lying. It simply is not about you.
- 1
The risk being insured is that you live too long
Nobody knows how long they will live, which makes spending a pot of money extraordinarily hard: too fast and you run out, too slow and you die with money you could have enjoyed. An annuity removes the question entirely.
- 2
It looks like a bad deal because it is priced as insurance
Compare the payout to what you might have earned investing, and it looks poor. That comparison is a category error. You are not buying returns. You are buying the elimination of a risk you cannot diversify away, and the insurer must be paid to take it.
The people for whom it worked out badly are visible. The people for whom it prevented destitution at 94 are not.
- 3
Inflation is the thing that quietly kills a flat annuity
A fixed income sounds fine and loses roughly half its purchasing power over twenty-three years at 3%. An inflation-linked annuity starts lower and is a different, usually better, product. The lower starting figure is not a worse deal, it is an honest one.
- 4
It does not have to be all or nothing
Annuitising just enough to cover essential spending, and keeping the rest invested, gives you a floor you cannot fall through and upside you can still enjoy. That combination is more sensible than either extreme.
You know the annual cost of your essential spending, and whether it is covered by guaranteed income.
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An annuity is not an investment. It is insurance against outliving your money, and insurance is not supposed to be a good bet.
We screen for yield AND the balance sheet behind it, because the biggest yields belong to the companies least able to pay them.