Thursday, November 14, 2013

Why Retirees Make Better Financial Decisions

     Do you get smarter as you get older, or do you slowly lose your mind? A recent study from the University of California, Riverside, and Columbia University, with the mind-bending title of Complementary Cognitive Capabilities, Economic Decision Making and Aging, has the answer.

     Researchers tested one group of 20-somethings against another group of people in their 60s and 70s, in various subjects such as basic financial literacy, knowledge about debt, how much they thought about their financial futures, and their tolerance for risk.

     Despite a general loss of mental acuity, the older group did better than their younger test-takers in virtually every category. How is that?

     Researchers explained the results by teasing apart two different kinds of intelligence. One is termed "fluid intelligence" and covers short-term memory and problem solving -- the ability to manipulate information and process it quickly. The other is called "crystallized intelligence" and involves the sum total of knowledge acquired through culture, education and a lifetime of experience.

     As we age, we lose fluid intelligence, but gain crystallized intelligence. The study concludes, For decisions that rely heavily on processing new information, it is likely that the negative effects of aging will outweigh its positive effects relatively early in middle age. On the other hand, if the decision relies on recognizing previously learned patterns in a stable environment, age may be an advantage.

     In other words, young people who can process information quickly will make better day traders. But day traders almost always lose money.

     Those of us who are more seasoned -- who have seen the ups and downs of the markets and weathered our own personal financial challenges -- are the ones who have achieved some wisdom, who make better decisions, who have the better approach to our financial lives.

     Here are a few specifics distilled from the study:
 
     Retirees have better knowledge of finance and debt. A greater understanding of debt contracts and interest rates leads older people to make better decisions in the real world. We are more likely to save and invest in the first place, then make better decisions such as choosing mutual funds with low fees. We avoid high-cost borrowing, such as credit-card debt, and also avoid incurring other financial costs such as high bank fees. How many of us carry over a credit-card balance? Not many, I'd bet.

      Older people have more control over their emotions. We are less likely to follow the crowd into a hot stock, only to lose our shirts. (Okay, my brother-in-law is the exception that proves the rule.) We are less likely to buy at the top, or sell at the bottom, and will not get sucked into a financial bubble that is going to burst. Who suffered the most during the housing bubble of the 2000s? Not retirees, but first-time buyers.

      We are "better at avoiding the influence of irrelevant alternatives." Older investors, according to the researchers, can tune out the noise from CNBC and other financial media, which give too much attention to the current news, even when it's not important to our actual investments. The latest new stock issue (think Twitter), or yet another impasse in Washington, can get everyone excited. But older investors know that this week's news is usually forgotten by next week.

      Older investors have a better sense of their own limitations. Young people tend to be overconfident. We older people have gone through some bitter experiences and know that we can sometimes misjudge things. And there is no more important quality in managing your finances than a bit of humility. Experienced investors know when to swallow hard and cut losses when they are still small, rather than wait and hope and pray that an investment will somehow work out when all the evidence says it will not.

      Seniors have more perspective and are more patient. We are not after the quick buck. We are more able to weather the ups and downs of the market, without panicking and changing our minds with every twist of the financial wind.

     Anyway, this is all what four academics from Columbia University and the University of California concluded. I think financial decisions are also largely determined by people's personalities. Some people are risk-takers; others are more conservative. Some people do their homework; others are more impulsive. But still, I think these researchers are onto something. I'm sure not going to argue with them ... especially since they make us seniors look pretty smart!

8 comments:

Anonymous said...

Somewhat related: One of the local news programs has been making a big deal lately about the brain changes that make elders more likely to fall victim to scams. The theory of the study (sorry I don't recall enough to know whose study it was) was that parts of the brain shrivel that allow us to discriminate scam from fact. We are too trusting.
Cop Car

Dick Klade said...

I think family backgrounds play a part as well. My contemporaries, raised by parents who suffered during the Great Depression, seem to be more conservative in financial matters than younger generations.

schmidleysscribblins.com said...

I agree with Dick. The Depression affected my parents, and their attitudes shaped my experiences as I grew up.

However, when I was younger, I was duped a time or two by some con artist selling something. Today, I can resist much, but sometimes, I may be too careful. Call it the once burned twice shy phenomena.

Anonymous said...

Schmidleysscribbins--Some of us have been around long enought to have been burned enough times that we wouldn't fall for anything!
Cop Car

gigihawaii said...

After the market crashed in 2008, we have not invested in it at all. David has a profit sharing plan at work that is being invested in mutual funds by his former employer's CPA, and those investments have been very good. That's why David intends to keep his money there for a few years.

DJan said...

I don't "play" the market, but I invested all my retirement funds into stocks and had to decide how to split it all up to insure I wouldn't lose everything. It was intimidating, but I think we made some good choices, since we only lost about 10% during the Great Recession and most has returned. Good post.

Stephen Hayes said...

Thanks for reinforcing the fact that I'm smart. I keep telling this to people but no one seems to be buying it.

Kirk said...

I started investing early, and I learned never to get out of the market during downturns. You just have to suck it up and stick it out.

During the 2009 downturn my investments were down a lot, but have recovered, and if you ignore the downs and ups have returned an annual average of 4% over the period.

My teenage daughters are not yet financially savvy, but the older one, in college, is frugal with her money. It's a good sign.