How Well Do Retirees Assess the Risks They Face in Retirement?

Planning for retirement has always been hard, because retirees face numerous risks – including outliving their money (longevity risk), investment losses (market risk), unexpected health expenses (health risk), the unforeseen needs of family members (family risk), and even retirement benefit cuts (policy risk). The questions are: 1) How important are these risks? and 2) Do retirees properly perceive these risks when making their consumption and investment decisions? To answer these questions, this brief, which is based on an earlier paper, systematically values and ranks the impacts of these various risks from both the objective and subjective perspectives. That is, it quantifies the magnitude of the objective risks that retirees face, repeats the exercise for retirees’ subjective perceptions of the risks, and then compares the two. The analysis, which uses data from the Health and Retirement Study, involves constructing a lifecycle optimization model to quantify each risk by estimating how much wealth retirees are willing to give up to insure against it. The discussion proceeds as follows. The first section presents the background on risks in retirement. The second section discusses the data and methodology. The third section presents the results, showing a significant disconnect between actual and perceived risk. The biggest risk in the objective ranking is longevity risk, followed by health risk and market risk. At the top of the subjective ranking is market risk, which reflects retirees’ exaggerated assessments of market volatility. Perceived longevity risk and health risk rank lower, because retirees are pessimistic about their survival probabilities and often underestimate their health costs in late life. The final section concludes that retirees’ misunderstanding of the importance of various retirement risks highlights the need for more education and provides unique insight into the need for lifetime income, either through Social Security or annuities, which hedge both longevity and market risks.