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.
Note: The link contained in this blog post will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.
Why has nobody mentioned youth’s lack of ability in these comments? The “hump” has an upward slope and a downward slope. If we propose to do something for people at some point on the advanced-age downslope, shouldn’t those below that same point on the youthful upslope get similar guidance/regulation/assistance/restrictions/et cetera?
Yes, youth have more time to recover from a loss, but consider that any loss while young is also a loss of the growth that another 30 to 50 years would have brought, too. A loss while young is “compunded” by the lost opportunity to grow that investment over subsequent years.
I ha hoped that this might be a more general comment on investing. Do cognitive skills help at all?
I index broadly and and have never thought that I or anyone else could consistently do better.
Am I wrong?
Question: Have you considered offering a fully diversified fund?
Individuals will certainly vary, but consider the implications for society as a whole. My grandfather and my father had pensions. These were, once they retired, a permanent source of income to cover basic needs of shelter, food, transportation. And they did not have to make any decisions or have any financial skills in that system.
Now consider my generation — there are no pensions, only IRAs and 401(k) plans. While people may do reasonably well in making financial decisions with them while they are young, once they retire they have significant decisions that must be made: what to sell, tax consequences, mandatory distributions, stocks versus bonds, and more. And this just to provide a steady source of income to live off of. No matter how well or how badly my father did with his investments, he still had a steady income from his pension. If I make the wrong decisions, I could lose everything that I have accumulated for retirement.
And I may well not even know if I have made a good or bad decision (or even know that I have made a decision). A previous study showed that incompetent people do not know they are incompetent.
My solution is to use some portion of my retirement savings to buy an immediate fixed annuity — basically to try to provide the pension my work does not provide — with the aim of providing a fixed, steady source of income to cover my basic needs. Then I can screw up everything else and still survive, independent of my failing financial…
How is financial intelligence measured at any age? If there is a way to measure it, there is a way to determine decline. It seems some seniors think they are making good decisions, not even recognizing the decline in themselves .
I’m Sure Warren Buffet would be surprised to know he has passed his prime. So would several million other admirers.
At age 67, my present age, I think I’m beginning to have some greater understanding about the stock market; after remembering month after month of paper losses, during the worst recession since the depression. I now know that I need to invest more conservitively in order to be financially secure in my semi-retirement. I’planning to sell my largest mutual fund which has been operated by unethical people. Many in Wall Street were greedy and probably some still are. —-Check out Lies About Mutual Funds to have your consciousness raised. The writer is out of touch with the understandings of senior citizens. Thank God, I’m doing pretty good right now.
The suggestion is most timely for me as I embark on the second quarter of my eightieth decade. I’ve begun to realize that I’m not able to do justice to a portfolio of only eight funds held in a Roth. Just this week I’ve consolidated to three index funds. This reduction correlates with less feelings of stress. How it affects the bottom line remains to be seen.
So Warren Buffet’s abilities have been declining for the last 26 years???
This is very sad. How much of what goes wrong for the average older person is really due to a serious decline in cognitive abilities versus what someone has done to confuse or intimidate that person? I have read stories about seniors who were convinced their relatives were trying to steal their money and continued making bizarre financial decisions until someone finally went to court and had them declared incompetent after having lost a significant amount of money in the mean time. However, what is much more common is that a senior who would have left their money alone and just continued to withdraw the same amount every month is tricked into withdrawing a large amount and giving it to a scam artist. Either the older person is made to believe that something bad was going to happen to their money and this new “friend” was coming to their rescue or that this new person in their life was sharing a special opportunity with the senior. Part of the problem is that current seniors are way too trusting. I wonder if this will start to change as the elderly population shifts more toward the post war/boomer generation.
As I read, I was nodding my head in agreement with the author, because at 75 I have to admit some mental slowdown. Then came the comments of indignant seniors whose minds, they feel, are full speed ahead. How about some sophisticated financial instruments and some simple, basic ones to suit both populations? My vote is for simplicity! I’ve had enough of complicated electronics, phones, computers, microwaves, etc., even language, that make me, with five years of college education, feel like a dummy.
I took the time to read the full article and am fairly convinced that the authors have not done much more than act like the proverbial blind man looking at the tail of the elephant who decides it is a skinny animal. I have an 85 year old father who is being deluged these days by unscrupulous vultures trying to separate him from his money. However their appeals have nothing to do with analytic function; they prey on older people’s emotions, not their logic. The sales people act really nice, they tell warm stories about their parents and their children, they fake concern and empathy and then when they have gained the elderly person’s trust, they prey on their fears of running out of money, of financial ruin, of being a burden on their children. They promise them they have just the solution to the problem and that it worked for their dear old parents and they just want to share it with everyone else because they are so good hearted. (Vomit)
It is much easier to explain any “U” shaped age effects by the affective side of the mind, not the analytic. Young people haven’t been burned enough yet to realize how suspicious they should be of sales people, so they fall prey to one set of stories and emotional appeals. Older people, for some inexplicable reason, become too trusting again and are taken in by a different set of stories and emotional appeals.
I plan on remaining cynical and suspicious of people selling financial products until the day I die. It’s your only real…
I think Vanguard has answered the “what to do” question in its article about retirement investing: simplify your portfolio”.
At 59, I have been responsible for all investment decisions for our family. I agree that your study may make some valid conclusions about cognitive abilities as we age. Also, people generally make investment decisions on what they know. Often with their very real bias toward asset allocation, sometimes without recognizing existing or changing market conditions. It also should be noted the very real Sea Change in markets that we see today due to the political and economic storm we are currently living through. All of these factors makes investment decisions very tough for young and old alike. It all boils down to our own individual judgement, and talent as investors. Plus our ability to realize if we have the skills to recognize how to handle investment decisions rationally and wisely for our individual or family needs.
I am 75, and while my cognitive skills have declined, my knowledge of the stock and bond markets has increased. How about for those of us who are facing declining mental faculties, simply going into the fine age-specific Target funds and maybe some tax-free bonds. Then one can forget it all and still stay safe.
In determining the equity portion of our portfolio, my wife and I use the rciprocal of our average ages. Prior to the recent meltdown, we had about 30% in equities.(our average age last year was 72)
I felt sorry when I heard of Senior Citizens “losing their life savings” in the crash. What were they thinking investing that heavily in equities as “seniors”?
With our mix, we lost about 12% and it’s coming back.
Investment agencies should put heavy emphasis on this rule of thumb for seniors so they would noy be caught up with “unreasonable exuberance” with equities.
What does Mr. Utkus mean by the pseudo-statistical quote “the prevalence of dementia doubles every 5 years after 60″? At 75, does he mean that I am now 8x more ‘demented’ than at 60.
The hump curve is a guide for the absolute max mental capabilities of a ‘typical’ individual over time. There is a another curve, that rises steadily, showing the accumulation of knowledge (and wisdom) with time of study/experience. At any age it is the lower of the two curves that defines the limit of any one person’s ability to make sound financial decisions; as 11.01.09 @ 12:02 (to his credit) has found out.
I don’t think ones cognitive skills declines over time. A twenty year old might respond a lot quicker to a situation than a seventy year old, but the seventy year old has fifty more years of life experiences to reflect upon (ergo the response delay). The key is staying involved. Two of the previous comments make my point. One senior who has lost interest and the other who follows financial developments. Best regards.
Very interesting, thanks. I study more (read and askVanguard and others for advice) and do more of my decision making every day. I’m 71. I have very good results.
Maybe true. Certainly it is true that our physical and mental ability declines as we age. I am 75 and I teach an AARP senior driving class. In driving, it is the total of eyes, reflexes, flexibility,etc, Total of mental and physical. Given the age related decline, we teach adaptation. How to be better with less. Same applies to investing. More education, more analysis, more effort. But we can still be the best.
It seems an obvious solution is to find a trustworthy advisor who one can lean on a little –or a lot–depending upon your needs. I’m 72 and make all of my decisions, but I often call someone–in my case a Vanguard advisor–and tell him what I am planning to do and ask whether he (or she) believes the decision is wise in view of my established goals and strategies. I’ve been pleasantly surprised to have been disuaded from decisions that I had believed were thorougly logical.Indeed, having an advisor look over one’s shoulder can be a great benefit at any age. I should add that I work neither for Vanguard or any other advisor.
I wouldn’t place a great deal of stock (so to speak) in this study except as a gross generalization — and as we all know, generalizations usually break down in individual cases. I’m 70 and have been investing successfully for about 30 years now, and the experience and knowledge I’ve accumulated over that time still serves me well. My advice to anyone, especially ’seniors,’ is simply to avoid the kind of sophisticated, structured products touted by many financial advisers. They’re mostly structured to produce income — for the broker.
Reality enlightens our awareness that we are losing, and will continue to lose, our (cognitive, or other) ability to make informed choices, or should I say, “lessen” our ability - and this becomes a real fear. Today, we may “diversify” (which I have) - but, considering our current, and expected future, economy - our choices today can be only “our best choice at the time”. Should we consider a younger person - a friend, relative, local professional - to make our future choices for us? (or is this your marketing intention anyway?) - but, how can they, how would they know, what our choices might be? What the future economy - U.S. or global - might include to color our choices? I will continue to think about this choice, keep diversified, keep global, invested in equities - but, I admit, I am concerned - but want to retain most of my savings for grandchildren’s education, hopefully not needing it for costs of illness or long-term care. It is a dilema we all must face, answer, and choose…….
Thank you for the “food-for-thought”
Interesting commentary and timely. My wife and I are 64. She is a Mathematician and I am an Economist, perhaps the best combination on the planet to build wealth. And we did. We have always considered ourselves pretty astute. Recently we had a trusted major corporation come out and replace our dishwasher. The installer turned out to be a con artist, saw us as easy elders to scam, and we were sucker punched paying more than twice what should have been charged for the job. A complaint with the company fixed the problem, but we were, in retrospect, humbled for the first time in our lives as consumers. This experience makes us pause and question our cognitive abilities as seniors. Each year we have a “financial project.” We decided what we’re going to do is to get the help of Vanguard Flagship services and automate our portfolio so that neither of us will have to make life-changing decisions as we age. Perhaps, you should also think about it?
Very thought provoking article! I’m 70, and my approach is to put the majority of my IRA (former 401K) with a fee-based advisor and retain a seperate investment account for as long as my “cognitive” skills are still there. So far, so good.
The unanswered question(s) for me would be: What is the RATE at which the young acquire financial skills/knowledge and what is the RATE at which we oldsters use it? This 54-year-old really needs to know!
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.