Welfare costs of suboptimal retiree decisions

Abstract

We make a novel investigation of welfare costs associated with various suboptimal decisions made by retirees, both analytically and numerically. We utilize a unique framework that incorporates recursive utility with housing, and also encompasses expected utility and recursive utility without housing as special cases. Our findings indicate that under-investment in stocks incurs lower welfare costs compared to an equivalent over-investment. Suboptimal allocations in bond holdings result in higher costs than similar misallocations in stocks. Choosing not to participate in the stock market is less detrimental than avoiding the bond market. Should retirees opt to simplify their decision-making by investing solely in one type of asset, it is less costly for them to invest exclusively in bonds. Overconsumption of housing is less costly than an equivalent underconsumption. Suboptimal consumption imposes the highest welfare cost. Decisions regarding consumption, housing, and savings are found to be more crucial than the choice of how to distribute liquid savings between stocks and bonds. Additionally, recursive utility model better captures retirees’ preference for bonds over stocks than expected utility model. Our results, which are consistent across various parameter settings, provide valuable insights for academics and policymakers aiming to enhance retiree welfare.