Population aging depresses returns on PAYG financed pensions, while low interest rates depress the return on funded pensions. This paper explores return, risk, and the preferred long-run mix of PAYG and funded pensions. On the one hand, the expected return on funded assets is substantially higher than the expected return of the PAYG pillar, partially due to aging of the population. On the other hand, PAYG pensions are less volatile than funded pensions, as the growth of the wage sum is less uncertain than asset returns if a 50-50 asset mix in fixed income and equity is assumed. To diversify risks stemming from demography and asset markets, a mix of PAYG and funded pensions is socially preferable. In the absence of within-cohort heterogeneity and transition effects, a transition from a 50-50 mix towards a larger PAYG pillar is only warranted at high levels of risk aversion.

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