ARLINGTON, VA (May 9, 2013) – In “Retiring in a Boom Market,” published in the new issue of 403(b) Advisor Magazine (available now), author Steve Sullivan reviews the “recency effect” and its implications in the average pre-retiree’s decision about when to leave the workforce.
When 403(b) advisors counsel their clients, it’s important not to allow emotion or bias to affect their judgment. It’s also important that they realize their clients are under no such constraint. Many, if not all of the decisions their clients may make are often based on rumor, unsolicited and unprofessional advice, and gut feelings. It may seem counter-intuitive, but when it comes to money, particularly the large and important sums associated with retirement planning, rational behavior often goes out the window.
Research suggests that some people decide when to retire—against all advice to the contrary—based on what the stock market is doing at the time. This is the finding of a paper, “Market Performance and the Timing of Retirement,” published last year by Dr. Rui Yao, an assistant professor of personal financial planning in the College of Human Environmental Sciences at the University of Missouri, Columbia. Yao used data from the Health and Retirement Study (HRS), a national biannual longitudinal survey conducted by the University of Michigan. The HRS, launched in 1992, has interviewed more than 27,000 Americans of diverse backgrounds over the age of 50. The interviews occur in two-year cycles and cover questions about their health, the state of their finances and their interactions with family and others in their communities.
Yao’s study, published in the Journal of Personal Finance and funded by a grant from Prudential Insurance, reviewed the financial and retirement status of more than 4,000 of these respondents, ages 51 to 61, between 1992 and 2008. It’s the first study to use these data to look at retirement behavior over that period of time. “We wanted to focus on pre-retirees, not people who were too young and weren’t planning to retire. Nor did we want to look at anyone who was too old and already retired.”
Yao’s study found that the decision to retire is often based on what the market is doing at that particular point. If the market is up, they’ll see it as a sign that this is the perfect time to retire. Behavioral economists call it the “recency effect,” the phenomenon that people tend to remember things at the end of a list or only the most recent events in time.
“The problem with this strategy is that the economy runs in cycles,” Yao says, ”meaning that after a peak, the market will inevitably take a downturn. People who have retired shortly before an economic downturn run a serious risk of losing a significant portion of their retirement savings, which will shorten the longevity of their retirement income. This could result in many retirees outliving their retirement savings and facing financial hardships toward the end of their lives.”
Advisors need to help their clients think more like actuaries, according to Yao. “They need to do the math. They need to project life expectancy. Nobody knows when they’re going to die but they all have some kind of expectation based on family history…”