In a recent encounter with a former student, Lewis Mandell, a professor of finance and managerial economics at the University of Washington, was asked: “What do you know about annuities? I’m thinking about buying an annuity.”
“I was really embarrassed,” Mandell said. I told him “you attended an entire semester of my investments course and know annuities are often laden with fees and that buying one at the bottom of an interest rate cycle might be a risk. You’re a smart guy, are you sure you want to buy an annuity?”
“Yes,” the physician replied, “I took your course and realize those things. My concern is—what do I do when I get stupid?”
Scientists no longer view cognitive impairment in old age as simply a misfortune that strikes some who suffer from a random event such as Alzheimer’s or a stroke. There is increasing evidence that cognitive decline in old age is natural and inevitable. In fact, the rate of decline in old age does not appear to be slowed by education or intelligence, and is unaffected by solving crossword puzzles or reading Russian novels. Our brains, like the rest of our body, lose their ability to respond quickly and precisely over time.
In a series of academic studies on cognitive aging, Timothy Salthouse, director of the University of Virginia Cognitive Aging Laboratory, tests mental functioning by asking respondents to perform tasks such as naming a synonym to a random word, detecting patterns or recalling a list of words. Coming up with a synonym is an example of a task that requires crystallized intelligence, or the ability to process a stimulus (the word) and relate it to an item in memory (the synonym). Tasks requiring processing and some knowledge or experience tend to peak in the late 50s. The other tasks require speed, reasoning and memory. These skills test fluid intelligence, which tends to peak in the 20s. Einstein’s so-called magic year occurred when he was 26 years old.
Like the synonym task, financial decision-making requires both the ability to respond to a stimulus and to place it into context through knowledge. Recent academic studies find that respondents make their best financial decisions when they are in their mid 50s. Sumit Agarwal, a senior financial economist at the Federal Reserve, and his co-authors found that effective financial behavior, such as limiting credit fees and interest rates paid on home equity loans, peaked in the late 40s and early 50s. Studies of investments confirm this financial performance peak in late middle age. George Korniotis and Alok Kumar, professors at the University of Miami, find that risk-adjusted investment returns decline with advanced age. Investors over 70 underperform by about 2% annually compared to younger investors.
A recent study using data from the Texas Tech Financial Literacy Assessment project shows that the decline in our ability to make basic financial decisions mirrors the results on investment and credit performance. The study 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. The rate of decline is no different at older ages, and a score at age 90 is about half what it was at age 65. Like other research on cognitive aging, this study found no increase in the dispersion of scores later in life, indicating a gradual decline among all older respondents rather than a few seriously impaired subjects dragging down the average.
While financial abilities decline with advanced age, confidence in one’s ability to make financial decisions does not. In fact, respondents in their 80s believe their financial knowledge is slightly higher than do respondents in their 60s. This inability to assess a decline in skills with age is not limited to financial decisions. Results from a new study conducted by researchers at the University of Alabama find that subjects over age 65 do not perceive their decline in driving ability despite clear evidence of reduced visual acuity and reaction times. In fact, older drivers who had multiple crashes were no more likely to rate their driving ability as worse than average.
This lack of awareness is a problem for a financial advisor managing the assets of a client who begins making questionable financial decisions. Eric Park, a financial advisor in Washington, Mo., describes the position of serving as a fiduciary to a client making questionable choices as a challenge. “Because of restrictive privacy laws, we find ourselves dancing around those issues. At the end of the day, every ethical planner has to ask himself how much legal exposure am I willing to withstand to protect [my]client. A planner who breaches privacy laws could very well find himself losing licenses, getting fined and even being subjected to monetary penalties or jail time.”
Planning for Decline
Notes Mitzi Lauderdale, an attorney and financial planning professor in Lubbock, Texas: “Planning for incapacity or partial capacity is crucial. Documents such as a durable power of attorney, medical power of attorney, will, trusts and advanced medical directives should be implemented well before any capacity concerns arise.”