Does Older Always Mean Wiser When It Comes to Finances?
It is often said that with age comes wisdom. When it comes to investing, however, new research suggests that this long-held doctrine may be only partly true.
Michael S. Finke, the head of Texas Tech University’s doctoral program in personal financial planning, has studied the effects of normal aging on cognitive functioning and financial literacy. What he and fellow researchers have found is that financial literacy—our ability to look at a new financial product or investment that we’ve never thought about before and assess whether it’s right for us—peaks in the early 50s and declines by about 1 percent per year after age 60, regardless of gender, race or educational attainment.
While other studies have observed that financial performance suffers as older investors advance in age, Finke’s research is the first to make a direct connection between investment performance and age-related financial literacy and the ability to apply knowledge correctly to financial decision making.
What You Don’t Know May Hurt You
There’s a twist to these findings, and it’s a surprising one. Even as financial literacy erodes, older investors tend to remain highly confident in their ability to make sound financial decisions and manage their own finances.
This mismatch between actual and perceived knowledge is especially worrisome in light of the fact that financial mistakes made later in life could leave retirees at greater risk of outliving their assets. Low levels of financial knowledge also may leave seniors vulnerable to financial scams.
In November 2014, the Center for Retirement Research at Boston University released a study that found, among other things, that overconfidence regarding financial knowledge is putting older Americans at greater risk of being victimized by financial fraud.
The issue looms large, especially as the number of older people continues to expand and longevity increases. According to the most recent U.S. Census Bureau data, there are 44.7 million Americans age 65 and older; by 2050, that number is expected to nearly double.
A False Sense of Security
Not surprisingly, cognitive decline and its impact on financial capability is becoming a hot-button issue, says Finke. “Older Americans collectively hold more than half of all investible assets in the United States, yet many are left to manage their own finances, even as they face low and declining financial literacy.”
The problem is that the signs of cognitive decline are often subtle, making them easy to miss.
“Like so many aspects of aging, the normal decline in cognitive functioning is a gradual process. People may not sense that they are losing their ability manage money with the same competency as when they were younger,” said Finke. “Because of this, many older investors and their loved ones often don’t recognize the impact that aging is having on their finances until it’s too late.”
Although each of us ages differently, Finke believes that it’s crucial to start preparing for cognitive decline by the time you reach your 60s, if not sooner. “In advanced age, your ability to process information and follow through, do calculations quickly, and understand financial concepts and identify risks deteriorates,” explained Finke. “However, this mental decline doesn’t have to lead to poor financial outcomes if you anticipate the possibility and take steps to protect yourself.”
Prepare for an Uncertain Future
According to Finke, one of the first steps you should consider is to consult an estate planning attorney to discuss and execute several critically important legal documents, including a will, financial and health care powers of attorney, a living will, and possibly a trust to protect your assets. “You want to take care of these sooner rather than later. Proper planning involves making complex decisions about the future that are best made before a retiree begins to experience cognitive impairment.”
Equally important, Finke believes it’s crucial to get your financial house in order. “Start by talking with your partner and/or children or other loved one about what you want the rest of your financial life to look like, including what should happen if you become mentally incapacitated either due to natural aging or because of dementia. Then think about what you can do to organize your assets so that you don’t have to make complex decisions as you age. That way you’re less likely to make an investing misstep that could jeopardize your financial security later in life.”
For a growing number of Americans, this means speaking with a trusted financial professional. “Financial professionals can perform a valuable role in recognizing cognitive ability and preventing financial calamity if they have the tools to provide assistance,” said Finke. “An experienced financial professional can help create a plan to last your lifetime. That includes identifying financial products that reduce the likelihood of financial mistakes, such as a deferred income annuity that provides a stream of guaranteed income later in life without significant investment management input.”
Your financial professional also can help you create what’s called a “letter of diminishing capacity.” This important document lays out a plan to deal with the possibility of cognitive decline, including how and when your financial professional should communicate with your family and/or attorney about your financial affairs.
Finally, Finke urges retirees to avoid the two big mistakes that many investors make as they age. “The first is thinking that cognitive decline won’t happen to you. The second is believing that you’ll recognize cognitive decline in time to get your financial house in order. The sooner you accept the realities of aging and the potential for cognitive decline, the better able you’ll be to create a plan to preserve and protect your financial security.”