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.
Click here for the
original article.