The 23rd annual Morningstar Investment Conference closed Friday with a lunchtime address from David Laibson, a professor of economics at Harvard University. Entitled “The Age of Reason: Financial Decision-Making Over the Life Cycle,” the hour long presentation provided attendees with a stark look at how society treats the elderly, especially in the financial realm.
He began by noting the “two faces of aging,” one that is of healthy, active seniors happily living out their retirement; the second is more bleak, with dementia involved more often than not.
“The movie The Note Book featured a woman suffering from dementia and memory loss,” he said. “The manner in which she is portrayed is one of an elegant, well-dressed senior that gave no hint that she was ravaged by the disease.”
He noted that 20% of those age 65 and older report being taken advantage with an unsuitable financial product. But he added the figure is significantly lower than reality, as many seniors never realize they were taken advantage of, and therefore unable to have it reported.
He then noted when individuals are age 20, they are charged higher fees and interest rates, on average, for loans. The fees and interest rates then decline until they’re in their 50s, before they begin to rise once again.
“You might say it’s a function of their finances, but the 20 and 65-year-olds had better FICO scores,” he said. “So why does this happen? I’d like to say all loans are commoditized, but the reality is they are a function of supply and demand, and depend on negotiating skills. The simple fact is those in middle age are better negotiators.”
He then turned to credit cards, and described the tactic many companies take by offering to waive interest charges for a year on balance transfers. Included in fine print is the fact that if any purchases are made using the card, the zero interest portion of the balance must be paid off first, and the high balance charges are paid off last.
“It’s a real life financial IQ test,” Laibson said. “Using the card immediately wiped out what was in essence an interest free loan. The old and the young didn’t figure it out.”
Increasing, we as a society have a psychological resistance to planning for our cognitive decline, and he listed specific problems that must be addressed.
- Lack of meta-cognition—we don’t remember that we have bad memories. If we did, we would always put our keys in the same spot so as not to lose them.
- Need for control—elderly individuals keep driving long past when most should stop.
- Over-optimism—most individuals don’t believe they will experience dementia, when statistics show many will.
- Procrastination—especially in planning for their possible cognitive decline.
- Aversion to complexity—people don’t know where to start when it comes to planning.
- Aversion to annuitization—annuities sound like a good plan to address some of the problems mentioned above, but brand recognition with the public is still largely negative. Even with annuities that are supposedly “good deals,” people walk away in droves.
From an income generation standpoint, Laibson argued the threat of outliving one’s assets is higher now than ever before.
“Approximately 75% of defined benefit pensions elect to be taken as a lump sum,” he said. “And only 5% of defined contribution plans are rolled into annuities.”
For the advisors in the audience, he listed four “must-have” documents to be provided to clients: a durable power of attorney; a living revocable trust; a living will; and, a health care proxy.
“Estate planning should be the default for every 65-year-old client,” he said. “Regular checkups should occur every three to five years where the next appointment is automatically scheduled, and family participation should be encouraged. The client should be able to opt-out of all of these, but opt-out should be the default.”
He stressed the business opportunity that will arise from addressing these types of issues. If advisors can protect assets from “mischief,” figure a way to convert wealth into consumption, insure against longevity risk, insure against inflation risk and provide older investors with a sense of control, then they will participate in the management of $10 trillion of financial assets and the $8 trillion dollars of real estate assets.
“But one of the first issues that must be addressed is the fiduciary issue,” he concluded. “We have it for 401(k) plan participants, but they are the least vulnerable, as they can keep working. The demographic that is most vulnerable, the elderly, does not have that protection. As a society, we’ve flipped the fiduciary issue, and we need to flip it back.”