When saving for retirement, seniors overestimate market volatility and underestimate life expectancy

For seniors who've stashed their money into stocks, bonds and mutual funds, recent market volatility could mean bad news for their retirement portfolios, especially as major stock indices such as The S&P 500 and Dow Jones are reporting significant year-over-year declines.

The high rate of inflation coupled with rising interest rates and a volatile stock market could mean seniors might need to adjust their retirement plans.

Should seniors alter their investment portfolios because of stock market dips and are they generally good at evaluating potential risks to their retirement savings?

The Center for Retirement Research at Boston College recently sought to answer these questions by using survey data from a 2016 Health and Retirement Study conducted by the University of Michigan and the National Institute on Aging.

Select spoke with Wenliang Hou, former senior research economist at the Center for Retirement Research, about what seniors tend to get wrong when it comes to saving for retirement, and Mark Pitre, principal at California Financial Advisors, about what they can do to weather market fluctuations.

In his 2022 brief, "How Well Do Retirees Assess the Risks They Face in Retirement?," which took a look at the results of the aforementioned 2016 Health and Retirement Study, Hou identifies five risks retirees should assess when it comes to saving up for retirement.

1. Health risk, or the risk of incurring unexpected healthcare costs
2. Policy risk, or the risk of future cuts to Social Security benefits starting in 2035
3. Longevity risk, or the risk of having a longer life expectancy than originally planned for
4. Market risk, or the risk of experiencing market volatility
5. Family risk, or the risk of facing additional costs as a result of divorce, the death of a spouse or your child (or children) getting sick or becoming unemployed

By asking respondents how likely a certain outcome was to occur, Hou found there was a mismatch between what retirees thought would be the greatest risk in retirement and what the greatest risk in retirement actually was: The greatest risk in retirement turned out to be not saving enough money, as many of the participants underestimated the length of their retirement horizon and amount of healthcare expenses they'd encounter. 

In the study, women between the ages of 65 and 69 mostly expected that they would live until age 80. In reality, there was a more than 75% chance these women would live beyond that point.

Hou explains that participants were often wrong about the length of their retirement horizon because they had calculated it based on what their parents' life expectancies had been, even though most people today can expect to live longer than previous generations.

Seniors in the study also overestimated the risk of market fluctuations affecting their savings. On average, respondents ranked market volatility as being the greatest risk, showing that retirees' expectations about market performance were generally more negative than actual returns.

Hou attributes people's negative outlook on the market to media coverage, which may focus more on short-term fluctuations in the market over long-term returns. 

So, how should seniors approach saving for retirement when they're susceptible to overestimating the volatility of the market and underestimating how long they'll live?

"We're coming off of a decade that saw the S&P 500 come in at about 15% to 16% [growth] per year," Pitre says. "The decade ended in 2021 with record-highs and zero [percent] interest rates, so looking forward, we're telling clients [to] expect a 6% rate of return for equities and 3% for fixed income."

Pitre also warns against assuming that the recent performance of the market will match its performance in the future. Keep in mind that while the Nasdaq Composite has declined nearly 15% in the past year and the S&P 500 has decreased almost 20%, the average annual return for the S&P 500, since its inception in 1957, is still around 10%.

While Pitre doesn't suggest investors make dramatic changes to their portfolio based on recent performance, he does recommend that retirees look into allocating more of their portfolio toward value stocks with a steady dividend stream.

Value stocks are thought to be undervalued by the market based on factors such as price-to-earnings ratios, so this asset class tends to have less volatility, says Pitre. 

Investing in individual stocks is generally more risky than investing in funds, so investors close to retirement may want to opt for value funds instead.

Stock funds, meanwhile, allow investors to buy a basket of different value stocks, which helps minimize risk — when the value of one company's stock decreases, it may be offset by an increase in value of another company's stock.

If you're saving for retirement, you're probably doing so through tax-advantaged retirement investment accounts such as a traditional IRA, Roth IRA or a 401(k), which is likely provided by your employer. Through these accounts, you may be given a variety of investment options, whether different types of mutual funds, exchange-traded funds, or individual stocks. 

Select ranked Charles Schwab, Fidelity Investments, Vanguard, Betterment and E*TRADE as offering the best IRAs based on factors such as fees and the number of investment options available. You can also consider a robo-advisor like Wealthfront which can build a custom portfolio for you based on your risk tolerance, age and investment timeline.

Correction: A previous version of this article incorrectly referred to Wenliang Hou as a former senior research advisor at the Center for Retirement Research. The article has been updated to reflect that Hou's title was research economist.

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