People are more likely to retire when the economy is doing well, according to a study published earlier this year by an MU assistant professor in the Journal of Personal Finance.
While the findings may not sound surprising, the consequences for personal savings and retirement timing can be far-reaching.
Rui Yao, an assistant professor in MU’s Department of Personal Financial Planning, wanted to know how large a role market returns played in an individual’s decision to retire.
Yao bases her concern regarding premature retirement on the unpredictability of the market. Once a person retires, the difficulty for reentry into the work force is exponentially greater than prior to retirement.
“That’s why we focused on the timing of retirement, to see if people can do anything,” Yao said. “Before you retire you can save, but after you retire you can’t do much. If the market gets bad, then not only will they see their resources being cut, they will also see they are not employable.”
She used elective retirement data from the Health and Retirement Study (HRS), and compared this data with the Standard & Poor’s 500 rates from the 12-month trailing return prior to an individual’s retirement.
Yao, and her partner in the study, Eric Park, found “the relationship between S&P 500 returns and the probability of retirement was significant and positive.” Essentially, people are more likely to retire during a market boom.
“Projection bias is a self-perception of what is going to happen in the future,” Yao said. “People extrapolate whatever the market is doing right now and project the future will be similar.”
There is inherent risk tying the decision to retire based on positive returns: “Given market variations, the possible downside of retiring at the market peak is twofold: Reaching target retirement wealth when the market is up does not provide the same security level as achieving the target amount of wealth when the market is down. The probability of retirement wealth experiencing a market correction is higher when the market is at its peak.”
Yao has examined the S&P 500 returns since 1926. She said the average return was between 7.5-8 percent, but during a market boom “people are going to project 10 percent or more,” thereby overestimating their retirement resources.
According to a 2012 Transamerica Retirement Survey, 51 percent of workers are “confident in their ability to fully retire with a comfortable lifestyle.” Confidence in retirement timing, Yao’s study finds, is further bolstered by a seemingly healthy market.
But Yao says a peak is exactly that – a peak. The market returns will diminish and retirees will be left struggling to decrease their consumption or reenter in a volatile job force.
“Market sequencing returns prove the earlier your retirement resources are hit by a low return or a negative return, the worse the longevity of your retirement income is affected,” Yao said.
Basically, if a market downturn happens early in one’s retirement, you have to decrease your spending or get additional income from another source to maintain the amount of money you had planned for your retirement.
Yao rejects the idea people planning for retirement are fully informed and rational decisions makers.
“We are emotional. We are human beings,” Yao said.
The outlook is not all doom and gloom, though.
A safe bet, says Yao, is to enlist the help of financial advisers. They help clients make retirement decisions based on their future goals, and educate clients against retiring in the midst of a feel-good market.