He Dies, You Make Money

He Dies, You Make Money

While it’s a different kind of future than we’re used to talking about – the concept of saving money for your future has been around before futures existed. But the way we save has been evolving ever since the word retirement has been around. The concepts of pensions, 401ks, and Roth IRAs are the first to come to mind; but not so long ago the most popular way of saving in the early 1900s was investing on the idea that others would die before you, called the Tontine. No, not this tauntan:

The Washington Post had a rather detailed report on how the now illegal retirement plan could potentially be the future of retirement plans that fill in the gaps of a pension plan or 401k.

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“Tontines, you see, operate on a morbid principle: You buy into a tontine alongside many other investors. The entire group is paid at regular intervals. The key twist: As your fellow investors die, their share of the payout gets redistributed to the remaining survivors.

In a tontine, the longer you live, the larger your profits — but you are profiting precisely off other people’s deaths. Even in their heyday, tontines were regarded as somewhat repugnant for this reason.

At one point, more than 9 million tontine policies existed in the United States, in more than 18 million households, representing around 7.5% of the nation’s wealth. Besides the fact that you take profit from others dying, it’s popularity led to lots of money coming into policies, and eventual fraud with those in charge of that money. Tontines were eventually banned in response, but some economists suggest that banning the concept might have been an overreaction. Via the Washington Post.

“This might be the iPhone of retirement products,” says Moshe Milevsky, an associate professor of finance at York University in Toronto who has become one of the tontine’s most outspoken boosters.

Suzanne Shu, an associate professor at UCLA’s business school, argues that such an arrangement can feel more psychologically fair. Retirees often object to annuities because they worry about not living long enough to make the money back. This is the nightmare scenario: If someone dies the day after she buys an annuity, the insurance company walks away with the cash scot-free. In a tontine, that money passes on to help fund other people’s retirements. (Depending on how psychopathic you are, this is either a positive feature or a murder incentive.)

We’ll leave the debate over whether someone can make more money by outliving others to lawmakers, but we can’t help but think a financial version of the Tontine would be a great way to ensure investors stick with their investments.

What if a mutual fund or hedge fund stipulated that 50% or so of your investment was redistributed to the other fund investors should you pull out of the fund before some set term (call it 5 years). No investors would agree to this, of course – but imagine the benefit it would have on the all too common problem of investors getting out at the lows and in at the highs. You would have a very clear incentive for not panicking during a down turn (panic and you lose 50% of what’s left), and would definitely think twice before pulling the trigger on that high flying fund (am I willing to endure a down turn for 3+years to not lose my money).

The goals of the investors and managers would be aligned – fees could come down because the managers would know their customer lifecycle more clearly; and long term investors could make money off their willingness to stick out an investment.

Maybe Tontines are how it works in galaxies far, far away where they have Tauntauns.

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