Older Americans Are Too Fearful About Money and Investing
Originally published in Market Watch on 08/07/2017
Growing income inequality in America is frequently named as the source of many problems the country faces, from a broken federal government to lagging economic growth. Despite its prevalence in the U.S., one group surprisingly bucks this trend: older Americans.
The numbers are surprising. Among households in the top 25% of earners for their age group, average income falls to $56,000 for people in their 80s and $32,000 in their 90s from $157,000 for people in their 40s, according to data from the Federal Reserve Board that United Income analyzed. By contrast, households in the bottom 25% of earners see their incomes fall by half during this same period.
Even more surprising: income differences among older Americans have been shrinking in recent decades, while they’ve been rising for nearly every other age group. Declining spending needs as people age is one reason why incomes converge as people age. Spending for mortgages and financial assistance to children, for instance, typically falls in retirement. Older retirees also usually spend less on travel and entertainment than do more active younger retirees.
These findings are significant because the magnitude of income reduction indicates that some of these more affluent retirees appear to be restricting their incomes (and thereby their spending) far more than necessary. In fact, the median high-wealth household in their 80s is worth 8,000 times more than the median low-wealth household — a difference of more than $800,000. This suggests that older Americans with considerable wealth are simply cutting back on their lifestyles, making the older population more equal in terms of income and spending.
Income differences among older Americans have been shrinking in recent decades, while they’ve been rising for nearly every other age group. Declining spending needs as people age is one reason why incomes converge as people age.
Fear of the future is partly to blame. In recent research at United Income, for instance, we found that older households expected stock market investments to decline in value every year between 2002-2014, even though major market indices increased in all but two of those years. Such unnecessary pessimism can create anxiety about withdrawing money.
Low-quality financial advice may also explain why income drops so sharply for wealthier households. In a survey of popular planning software used by advisers, for instance, we found that these tools overestimate required spending or ask advisers (unrealistically) to guess about future spending needs, which may lead to overly large estimates and further stoke unnecessary fears about the future.
Retirees are also targeted with simple rules of thumb that can be dangerously misleading. One example is the so-called 4% rule, which says you can safely withdraw 4% of your nest egg in the first year of retirement and then adjust that dollar amount for inflation each year. While some are debating whether to change that amount because of low interest rates, they miss the point: you can make income constant in retirement, but you can’t do the same for spending. In a recent analysis of 10,000 retirees, we found that the average 70-year-old experienced a 10% change in spending over a two-year period.
Low-quality financial advice may also explain why income drops so sharply for wealthier households.
Perhaps the most surprising finding is that while these problems facing older households are driving a rare income equality trend in the U.S., it actually may make income inequality worse overall. That’s because households over 50 own $18 trillion in investable assets, or 80% of all consumer investments. Keeping much of that locked up in investment accounts and on the economic sidelines reduces job supply, which stifles wage growth and perpetuates income inequality.
What to do? Educating ourselves about how investment attitudes can become overly conservative as we age is one place to start. Higher standards for the quality of financial planning software products is also long overdue. Just as we have benchmarks to assess investment performance, there should be standards for what constitutes “good” and “bad” performance of financial plans and their assumptions about the future. Moreover, the cost for financial planning needs to be lowered to give more people access to the benefits it can provide.
Through steps like these, older Americans can improve their retirements, and the noble goal of greater income equality will be the result of rising incomes from the bottom, not needlessly falling incomes from the top.