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!