Americans Underestimate Two Major Kinds of Retirement Risk

U.S. consumers are terrified of ups and downs in the stock market, but blissfully unaware of the risk that they could live to age 80, or face big nursing home bills.

Wenliang Hou, a Fidelity Investments analyst, has come out with a new snapshot of retirement savers’ understanding of risk in a new research brief.

Hou, previously a research economist at the center, created the snapshot by coming up with his own picture of the major risks U.S. retirement savers face, and then comparing his results — which he classifies as objective — with the U.S. consumers’ own estimates of the risks they face.

Hou found that, from his perspective, U.S. consumers ages 50 and older were about three times as worried about market risk as his modeling suggests that they should be, 30% less worried about medical bills than they should be and 50% less worried about living a long time.

What It Means

Hou says his research confirms what you might find when you hear ordinary people talking about their finances: Typical Americans have much different ideas about what they’re up against than economists do.

“Retirees do not have an accurate understanding of their true retirement risks,” Hou contends. “The finding highlights the importance of educating the public on the most significant sources of risk.”

Hou sees the lack of awareness of long-term risk as being especially frightening.

“Better designed public programs and private products, possibly integrated with life annuities, could be encouraged to protect retirees with limited financial resources from this potentially catastrophic risk,” Hou writes.

Methods

The new brief is a short, advisor-friendly version of a 77-page research study that Hou completed in 2020.

Hou came up with what he classifies as “objective risks” modeling by using mortality data from the 2019 Social Security Trustees report and data on acute health care and long-term care spending from the 2016 wave of the University of Michigan’s Health and Retirement Study survey series.

The Health and Retirement Study survey team interviews about 20,000 U.S. household members ages 50 and older every two years.

To model financial risk, he used Wilshire 500 stock price data for the period from 1972 through 2019, and S&P/Case-Shiller Home Price Index data for the period from 1988 through 2019.

Part of the Health and Retirement Study questionnaire asks participants about their thoughts about the probability of living to certain ages; their expectations for medical and long-term care for the next year; and their thoughts about the probability that stocks and home prices will gain more than 20% in value or lose more than 20% in value over the next year.

Hou used the answers to those survey attitude questions to develop what he describes as “subjective expectations” data that he could compare with the objective risks figures.

He then calculated how much initial wealth people should be willing to give up to eliminate specified risks.

Results

Hou predicts, for example, that single men who retire should be willing, based on economic analysis, to give up 27% of their initial retirement wealth to eliminate longevity risk, 14% of their initial wealth to eliminate acute health and long-term care health risk, and 11% to eliminate stock market and house price fluctuation risk.

Instead, in the real world, the subjective analysis implies that those men are willing to give up only 15% of their initial retirement wealth to eliminate longevity risk, barely 9.6% to eliminate health spending risk, and a whopping 31% to eliminate stock market and home price market risk.

“The health risk is not as large as in the objective ranking, because retirees significantly underestimate their medical expenses in old ages,” Hou says.

Subjective market risk is high because typical men think market volatility is much higher than it has been, Hou adds.

Study Limitations

Hou used stock and housing market figures that leave out the current stock slump. The figures do include the impact of several other recessions, including the 2007-2009 Great Recession.

His life expectancy figures come from the period before the COVID-19 pandemic.

Actuaries and others are still debating how to build the impact of the pandemic into life expectancy projections, and any models that include life expectancy projections.