Studies Show Age Affects Financial Decision Making

Studies Show Age Affects Financial Decision Making

Cognitive impairment in old age may not simply be the result of a random event such as Alzheimer’s or a stroke. There is increasing evidence that cognitive decline in old age is natural and inevitable, and cannot be slowed by education or intelligence, nor by so-called brain exercises such as solving crossword puzzles. Our brain, like the rest of our body, loses its ability to respond quickly and precisely over time.

Research Magazine recently reported on several academic studies focusing on financial decision making and age. One study led by Sumit Agarwal, a senior financial economist at the Federal Reserve, found that effective financial behavior, such as limiting credit fees and interest rates paid on home equity loans, peaked for participants in their late 40s and early 50s. A study by George Korniotis and Alok Kumar at the University of Miami found that risk-adjusted investment returns decline with advanced age. They determined that investors over 70 underperform by about 2% annually compared to younger investors. Lastly, a recent study using data from the Texas Tech Financial Literacy Assessment project found that the ability to understand financial concepts and apply them appropriately peaks in the early 50s and declines by about 2% per year after age 60.

Interestingly (and perhaps unfortunately), although financial abilities appear to decline with advanced age, confidence in one’s ability to make financial decisions does not. In fact, respondents in their 80s believed their financial knowledge is slightly higher than did respondents in their 60s. Researchers at the University of Alabama found a similar result with driving. Older drivers who had multiple crashes continued to rate their driving ability as average.

If these findings are correct, what can you do to avoid making financial decisions that are not in your best interest as you get older?

One approach is to get professional help. There are over 60,000 Certified Financial Planners in the U.S., many of whom are Registered Investment Advisors that are required by law to put their clients’ interests ahead of their own. Of course, unscrupulous advisors can be found in almost any profession, but there are also ways to ensure that your advisor does not take advantage of you. (See https://www.cognizantwealth.com/2012/06/19/five-simple-tips-to-help-seniors-avoid-investment-fraud/)

Another possibility is to give a trusted spouse, adult child, or friend the power to manage your financial affairs through a durable power of attorney. Everyone should do this in any case, if only to ensure there is someone available and prepared to pay your bills and manage your cash flow should you become incapacitated. As you age, the importance of having an agent to manage your affairs becomes greater and greater.

If you like to manage your finances by yourself, you can make and document important decisions before you get old. Putting together a financial plan while you’re still in your 40s or 50s is an excellent way to define expectations and the consequent financial decisions to be made. You can also do for yourself what most financial planners do for their investment clients: create an investment policy statement (IPS) that specifies the types of investments and the investment allocation strategy to be utilized. If you do this correctly while you’re still young, it should remain valid throughout the majority of your post-retirement years.

Aging involves numerous risks, not the least of which is cognitive impairment. If you’re not yet a senior, this would be a great time to take the steps to protect yourself from your (future) self.

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