Cognitive skills and financial choices
How does your ability to make financial decisions change over time?
One research study suggests that, across the population, financial skill follows a hump-shaped pattern. In our youth, we start with low levels of financial knowledge. Over time, our ability grows through experience. However, as we age, our cognitive faculties begin to decline. Over time, the decline in ability outpaces the growth in experience, and as a result our net ability falls. Hence the idea of a hump-shaped curve: from a low in youth, to a peak in middle age, to a slope downward in our older years.
What’s the magic turning point? The researchers estimate age 53 as the age of peak financial decision-making. Coincidentally, I just turned 52—and so if I am like the study averages, I can anticipate another year of strong financial decision-making, followed by a slow but inexorable decline.
This question of cognitive skills is one of the more vexing questions we face in an aging society. Of course, there will always be a large cadre of older individuals who are able to make informed financial decisions on their own. Yet there is an expanding group of older adults unable to comprehend all of the details needed to purchase modern financial products. As the researchers note, the prevalence of dementia doubles every five years after age 60. What’s more, older decision-makers are affected by milder cognitive difficulties not associated with a formal dementia diagnosis.
At a social level, it’s hard to imagine what the path forward is on this issue. Do we create a set of ultra-simple financial products through regulation? But not everyone is impaired, and some households will want to use sophisticated financial tools. Do we require everyone to complete a questionnaire about his or her skills before buying complex products? That’s hard to administer—and hardly fair if it targets only older decision-makers. Do we impose higher standards of conduct in the case of impaired decision-makers? But then how do financial providers know who is impaired, and isn’t?
Whatever solutions emerge, the question of cognitive skills is not going away, especially in a globally aging world. The financial world is only growing in complexity. Think about the financial decisions that older households face in terms of loans and credit, investments, insurance, reverse mortgages, supplemental health insurance, and so on. (And it’s not just the financial world—have you bought a new car lately?) If that complexity poses a challenge for inexperienced young decision-makers, it is certain to prove daunting for older households struggling to make informed choices.
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If I needed a CFP I would insist on a person in their 70′s vs one in their 20′s or 30′s; a person who is “seasoned” and who is in tune with the psychological nuances that sometimes irrationally drive the market.
Is John Bogle available? Where would Vanguard, and many followers be, without his indexing wisdom? “Steer the course!”
The whole concept of decline as we age is meaningless. Certainly we decline, but the question is from what level. Asuming that dementia is not an issue it is really more about slowing down, rather than becoming ignorant and/or stupid. A person with a high grasp of financial issues at 50 will still have a high grasp of financial issues at 80. The real problem is with those who never had much sophistication in the first place: If you struggle with understanding the issues at 50, then of course it will be much worse at 80.
I must be getting too old to function – I can’t figure out what this article has to do with anything other than reminding us once more that the elderly have always been prey to the unscrupulous. (The young have nothing much to steal.) That thought is always in the back of my mind as I receive my daily solicitations and free dinner offers from the hucksters out there who know I am turning 65 thanks to the State selling their citizens’ driving license records to anyone with a check that doesn’t bounce. Did Madoff have any young investors?
It takes about 5000 hours to claim a reasonable familarity with a subject. At that point the axiom of investing HOW MUCH CAN YOU LOSE has made itself apparent. It takes another 20000 hours to arrive at the wisdom of keep it SIMPLE. Given the only free lunch the market will give you is DIVERSIFICATION you will need 4-6 indexed mutul funds and/or 5-12 individual stocks in a minimum of 3 SECTORS AND 5 INDUSTRYS for which you must spend one hour per stock per week to avoid character building experience. The ALLOCATION of the assets reqire LIFE CYCLE TIMING dictated by your health, budget, and your revenue stream–this is not MARKET TIMING.
I have used financial instruments since 1956. Be in the market when all boats are rising and the story makes sense. Take profits and always have CASH in order to buy that $0.78/lb tomato–and never buy the $2.29/lb tomato (52 week high) In falling markets remain only in safe dividend stocks paying out less than 2x earnings per share with no to low-low debt. In confusing markets when nothing makes sense, get out. Buying six months after a bottom is better than 6 months before.
I think the study/rationale that folks over 53 start loosing their cognitive skills to make financial choices is very inaccurate/bunk. Even though the study identies individuals with excellent creditials,It seems to me that the study was done/requested to direct older to direct their money (older people have the money) to be managed by a financial advisory firm/government. I’m 65, I direct my own IRA which has substantially out performed another IRA that I had professionally managed. I fired that advisor/firm. The firm was not Vanguard where I still managed the IRA in a brokerage account. A complimentary review is held yearly. It’s just the support that I need.
Maybe Vanguard needs to open a final Target Fund for the Cognitively Impaired.
Just kidding. I did not find the article particularly helpful. The question always is when do you know that you are no longer competent to handle your own affairs.
all i have to say is that this is a pretty depressing blog post
I followed the link and read the abstract for the research cited in this article. The abstract states that “Financial mistakes include suboptimal use of credit card balance transfer offers, misestimation of the value of one’s house, and excess interest rate and fee payments.” Nothing is mentioned concerning mutual funds or other investments. I wonder whether this research has any relevance to long-term financial planning in later life (or at any other stage of life, for that matter).
I’m sure Warren Buffet knows he’s past his prime. He’s pretty in touch with reality. But that still leaves him smarter than nearly all of us.
I for the third time have taken finacial advise from an expert and again lost money. I made an average of 8.6% from 2006 to 2009 during the rough period of 2008. I have been told that market timing is not important from my advisor and lost my 10 months earnings in 1 week after following advice.
I think I over simplify my own financial affairs. I look at an investment mix for the amount of return I need to get on my money. I take no more risk than I need.
Sounds like just another pitch to sell financial management services to the swelling senior demographic. Didn’t expect this from Vanguard,
torch-bearer of passive indexing.
I agree that aging related cognitive decline poses major challenges for financial decision making. The myriad of choices available is confusing for the average person. There is a lack of guidance available for making decisions in important areas such as finance and health care choices. Many people are not well informed enough to make the right decisions even at the college educated level. So they either go for the safest product or take high risk without understanding the implications. As an immigrant Post-Doc twenty+ years ago I remember being told by the human resources dept of a major university that they would not give any advice on my choice of medical plan! To a new immigrant who had no one to go to for guidance it was a rude awakening indeed. Being a well educated person, I finally got my information at every turn and twist in the road of life, from health care to financial decision making, but I still find it way to complicated. There are way too many choices available. When faced with 3 fruits, one can make a quick decision, but when one is given 12, it becomes a long drawn affair. What an inefficient way to live!
There needs to be a non-profit agency to help those who need advice. Or a charitable organization that gives free advice. The internet has many resources, but it is also filled with scam artists. The bottom line becomes who can you trust? Friends and family help, but what if in old age, one does not have well informed family or friends to help
I’m suprised at the tone on this message. It seems like it is more of a sales pitch for selling some program to seniors than an informative piece for investors.
If the former is the motive, I’m disappointed that Vanguard would stoop down to the level of most of the financial industry with a message of fear disguised with a vail information.
I am shocked and dismayed at the rampant greed and lack of morality in the govermment and private sector of our financial system. This only the second time in many years I’ve been disappointed with Vanguard.
My hope is that Vanguard does not succome to greed and fall into the gutter of the financial sewer but continues to take the moral and ethical high road.
What I need is a potfolio that grows slowly over time and produces enough of a return over 5-7 years to pay for a car or emergency expenses. I don’t like huge drops in the assets.
I managed to get through 40 credits of chemistry and calculus so I think I can muddle through the moving parts of a variable annuity at any age.
The main idea “cognitive skills”en ability to make informed decisions at the increments of age.Scientific mental em balancing that prevail at 42 .Other wise I am
completely capable of making financial decisions even until the ripe older age of 98
Sincerely,
Interesting discussion. I explored funds when in my fifties, with little success. Took the plunge into learning to invest in the market in my seventies and after initial mistakes began to do pretty well. Got out when my husband appeared to be needing long term care. Most of my savings were in long term Government bonds and CDs, the latter being laddered in recent years. Now, with interest rates so low, I am putting my toe back into investing in stocks and bonds. At the age of 88, I am finding it interesting again and am going slowly. I have no idea where or how to find a reliable financial planner, since I no longer live in my home town but in a large suburban area. My friends here come from all over, too. And, by the way, those who have financial planners lost a good bit in the recent down-turn. I not only maintained my principle but added to it. However, my “hump” could come any time now, with illness or the like. I would like to consider a planner if I knew how to find one and what is a reasonable fee.