Planning for retirement is challenging. That’s especially so for those with limited resources, because they face numerous risks.
Adding to the challenge is a major discrepancy between how pre- and present retirees perceive those risks and what empirical research shows the main risks really are, according to a recent study.
- Mortality or longevity risk, meaning that the retiree may either die young without consuming all of the wealth or live longer than expected after exhausting all the money;
- Market risk, such as bad stock returns or a decline in housing values;
- Health risk, defined as unexpected medical expenses and long-term care needs;
- Family risk, including the death of a spouse or the unforeseen needs of family members; and
- Policy risk, mainly a Social Security benefit cut.
Hou systematically ranked these sources of retirement risk from both an objective perspective — what the numbers show — and a subjective one — how retirees perceive them.
In other words, he asked, do individuals over 50 rank their future financial risks the same as the empirical evidence?
His analysis shows that the biggest risk in the objective ranking is longevity risk, because it affects the planning time horizon for retirement life. Health risk follows, mainly due to the unpredictability of medical expenditures in later life.
Market risk ranks third on the basis of retirees’ relatively long investment horizon, which is about 20 years for average life expectancy.
Family risk and policy risk rank fourth and fifth, respectively; the latter because Social Security reform is unlikely to significantly affect people who have already retired, Hou says.
For the subjective perspective, Hou relied mainly on data from the Health and Retirement Study, a biennial longitudinal survey of some 20,000 Americans over age 50.
In this research, market risk ranks highest — reflecting what Hou calls retirees’ “exaggerated assessments of market volatility.”