Stock Market Perceptions Sabotage Savings

In the report, “Investment Decisions in Retirement: The Role of Subjective Expectations,” issued by the University of Michigan Retirement Research Center, researchers conclude that misperception about stock market returns can be addressed by various forms of education, information and exemplary behavior. They concede that although misperceptions are likely to be persistent and such programs will not reach everyone, there is a large scope for such programs.  

The researchers note that standard lifecycle models of economic behavior predict that essentially everybody should invest in risky assets to some extent, which is greatly at odds with the less than 40% of households in the research data that are observed to own stocks. In addition, according to the report, conditional on stock holding, standard models with realistic values of preference parameters predict much higher fractions of wealth invested in risky assets than they observe in the data.   

In the highly technical report, the researchers explore to what extent subjective expectations about stock market returns that differ from historical returns affect stock market participation. Model simulations show that when subjective beliefs diverge from historical returns, portfolio choices informed by the former have important welfare consequences. The researchers estimate welfare losses ranging from 3% to 12%, depending on the degree of individual’s negative perception of the stock market and the way historical returns are computed.   

The report is at http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp274.pdf.