Pay-As-You-Go System [CapiPedia]

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====== Pay-As-You-Go System ======
A Pay-As-You-Go system (often abbreviated as PAYG) is a funding model where current contributions are used to pay for current expenses, rather than being saved or invested for the future. Think of it as an immediate in-and-out flow of cash. This model is the backbone of most public [[pension]] systems around the world, including the US [[Social Security]] program and state pensions across Europe. In this context, the social security taxes paid by today's workers are not saved in a personal account for their own retirement. Instead, that money is immediately transferred to pay the benefits of current retirees. This is fundamentally different from a //[[funded system]]//, such as a 401(k) or a personal investment account, where your contributions are invested in assets like [[stocks]] and [[bonds]] with the goal of growing over time to fund your //own// future liabilities. The PAYG model is essentially a social contract, a continuous financial handshake between generations.
===== How It Works: The Generational Handshake =====
The mechanics of a PAYG system are straightforward but rely on a delicate balance. The system collects mandatory contributions (usually through payroll taxes) from the current working population and a portion of their employers. This pool of money is then immediately distributed as benefits to those who are currently eligible, primarily retirees, but also including disabled individuals and survivors.
The system's health depends entirely on the ratio of contributors to beneficiaries. For it to remain stable, there must be enough workers paying into the system to support the number of people drawing benefits from it. This is why political and public debates around PAYG systems often focus on three key levers:
  * The contribution rate (how much workers pay).
  * The benefit amount (how much retirees receive).
  * The retirement age (when people become eligible to receive benefits).
Changing any one of these variables has a direct and immediate impact on the system's solvency.
===== The Value Investor's Perspective =====
From a [[value investing]] standpoint, a PAYG system is not an "investment" in the traditional sense. It's a government-managed [[transfer payment]] program. You are not buying a stake in a productive asset that generates [[cash flow]]; you are buying a claim on future tax revenues, which is subject to political and demographic winds.
==== The Core Risk: Demographics ====
The greatest vulnerability of a PAYG system is [[demographics]]. The model was designed in an era of high birth rates and shorter life expectancies, creating a wide base of workers to support a small number of retirees. Today, that pyramid is inverting in many Western countries due to two powerful trends:
  - **Longer Life Expectancy:** People are living longer in retirement, meaning they draw benefits for more years than originally projected.
  - **Lower Birth Rates:** Fewer babies being born means a smaller future workforce to pay into the system.
This creates a squeeze on the [[dependency ratio]]—the number of retirees per active worker. As this ratio worsens, a country faces difficult choices: drastically increase taxes on a shrinking workforce, cut benefits for a growing number of retirees, or raise the retirement age significantly. For an investor planning for retirement, this demographic risk means that the pension benefits promised today are not guaranteed to be the same in real terms 20, 30, or 40 years from now.
==== Why It's Not a True Asset ====
A value investor seeks to buy assets for less than their [[intrinsic value]]. But a PAYG pension entitlement has no intrinsic value in a business sense. It has no [[book value]], no factories, and no intellectual property. Its "value" is a political promise, which can be altered by future governments. Unlike a company, its solvency depends not on brilliant management or a competitive moat, but on the demographic and political climate. This uncertainty is precisely what a value investor seeks to minimize.
===== Key Takeaway for Your Portfolio =====
While a state pension from a PAYG system is a crucial part of the social safety net, you should view it as a foundation, not the entire structure of your retirement plan. Its future purchasing power is subject to forces well outside of your control.
The core lesson for a prudent investor is the importance of **self-reliance**. The uncertainty surrounding PAYG systems underscores the need to build your own //funded// retirement pot through diligent saving and investing in productive assets. By owning a diversified portfolio of wonderful businesses, you are not relying on a generational promise but on the power of [[compounding]] and the cash flows generated by real companies. Treat your state pension as a potential bonus, but plan your financial freedom as if it won't be enough.