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Cognitive declines + increased confidence = financial mistakes

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As people age, they experience a toxic combination of declining financial literacy and increasing self-confidence. So says a new study conducted by researchers at the University of Missouri and Texas Tech University.

Cognitive declines are inevitable in advancing age, but the study demonstrates that those declines also apply to financial decision making. Coupled with stronger self-confidence, these declines often lead to financial mistakes and vulnerability to fraud, said the study.

The high-profile drama surrounding businessman and media magnate Sumner Redstone provides a vivid illustration of how cognitive declines experienced with advancing age can impact finances, said John Howe, professor and chairman of the Department of Finance at the University of Missouri’s Trulaske College of Business. Redstone is currently embroiled in high-profile legal battles that involve his daughter, a purported love interest, the fate of his $42 billion empire and questions about his mental competency at 92 years old.

“By the time you’re 92, most people ought to probably have a trusted advisor,” said Howe, who led the study along with Michael Finke and Sandra Huston from Texas Tech University. 

The study, “Old Age and the Decline in Financial Literacy,” surveyed more than 3,850 individuals aged 60 and older to determine whether they were experiencing decreasing financial literacy, defined as the ability to understand and make good decisions about personal finances. Respondents were asked 16 multiple-choice questions about basic finances, borrowing, investing and insurance.

The study also asked respondents how confident they felt in their ability to make sound financial decisions. The study found slightly increased levels of self-confidence among the respondents. Even though they didn’t understand financial terms or policies well, they still believed they could make good decisions about their personal finances, the study found.

The study controlled for education level, income and wealth to determine the actual effect of age on financial literacy.

“Mixing a decline of financial literacy with an increase in self-confidence is a toxic combination,” said Howe. “This opens the door for more honest mistakes as well as fraud. It’s widely known that older adults are very common victims of financial fraud. It’s important that as we age, we find someone who has our best interests in mind when managing our finances.”

Howe recommends consumers meet with financial advisors who have a good reputation, but don’t necessarily choose the first advisor they meet with. Consumers should ask friends and family for recommendations, and then choose an advisor with a good record who is willing to take time to answer questions, including about how the advisor will be compensated.

It is crucial to put these advice mechanisms in place before the onset of cognitive decline, said Howe. 

“The results of any kind of academic study are averages and there’s variation around those averages,” said Howe. “When a significant degree of cognitive decline shows up really varies from person to person. Our data shows that things don’t get much better after about age 50, but the first noticeable declines start in the mid-60s, so there’s a long period of plateauing.”

Because it’s impossible to know when significant declines will begin, people should ask their physician to evaluate them for signs of cognitive decline at annual checkups. Consumers should also plan to schedule an annual financial checkup with their advisor to ensure financial decisions are clear, said Howe.

“Cognitive decline is difficult even for medical professionals to determine,” said Howe. By the time cognitive declines are evident, it’s important to have a plan for when and how to turn financial decisions over to a trusted advisor, he said.

“It’s a tough question. If you are managing your own finances now, when might you turn it over to an advisor? That’s a tough one because everybody’s cognitive decline is happening at a different rate,” said Howe. “It’s hugely important to the individual, but it’s also hugely important to society that people who have become not terribly capable of making financial decisions can turn it over to someone who is trustworthy and can do it. Scam artists work a lot on old people and part of that is because their cognitive abilities have declined.”

While the study didn’t evaluate why self-confidence increases with age, Howe pointed to labels within the field of psychology that distinguish between fluid intelligence and crystalized intelligence. Fluid intelligence is raw intellectual power, while crystalized intelligence is knowledge gained from experience and past learning. Increases in self-confidence as we age, said Howe, could be related to crystalized intelligence that provides a sense that we have learned how to make good decisions based on lessons learned from previous good and bad decisions.

See also:

How to battle irrational financial behavior

Doctors, education aid in decline of financial elder abuse

High up-front costs spook cognitively impaired investors

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