Managing retirement resources: Evidence from the HRS

Abstract

Households are required to make a variety of decisions in pursuit of their retirement goals. These decisions are often complex and require the estimation and input of multiple factors when analyzing alternatives. Complexity and uncertainty have been found to lead to behavioral biases and a dependence on heuristics when making decisions. These deficiencies create a failure to incorporate valuable information, an overreliance on recent events, and inaccurate estimations of future outcomes. When these factors are combined with widespread low levels of financial sophistication and declining cognition the result is often behavior that is contradictory to rational expectations and detrimental to lifetime wealth and utility. Households are bound at a variety of levels by the limitations described above. Sophisticated households and those with higher levels of cognitive ability are more likely to participate in financial markets, enjoy higher returns on investments, and greater levels of wealth. Those with less sophistication and cognitive ability may fail to understand complex financial products, have less consistent preferences, and be more likely to engage in behavior that is inconsistent and detrimental to long-term goals and overall well-being. Given the variation in levels of financial sophistication and cognitive ability, we seek to evaluate how households make decisions in the face of market complexity, and in some cases how these decisions affect financial outcomes. Using the Health and Retirement Study (HRS) we give special focus to the decisions and behavior of older households. We look specifically at the impact of financial sophistication on individuals’ ability to accurately value life annuities, how cognitive ability is related to stock reallocations during the great recession, and how cognitive ability relates to the asset decumulation decisions of retirees.