The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation

Abstract

Many consumers make poor nancial choices and older adults are particularly vulnerable to such errors. About half of the population between ages 80 and 89 either has dementia or a medical diagnosis of "cognitive impairment without dementia." We study lifecycle patterns in nancial mistakes using a proprietary database that measures ten di erent types of credit behavior. Financial mistakes include suboptimal use of credit card balance transfer o ers, misestimation of the value of one's house, and excess interest rate and fee payments. In a cross-section of prime borrowers, middle-aged adults make fewer nancial mistakes than younger and older adults. We conclude that nancial mistakes follow a Ushaped pattern, with the cost-minimizing performance occurring around age 53. We analyze regulatory regimes that may help individuals avoid making nancial mistakes. Some of these regimes are designed to address the particular challenges faced by older adults, but much of our discussion is relevant for all vulnerable populations. We discuss disclosure, nudges, nancial driving licenses, advanced directives, duciaries, asset safe harbors, ex-post and ex-ante regulatory oversight. Finally, we pose seven questions for future research on cognitive limitations and associated policy responses.

Numeracy, Financial Literacy, and Financial Decision-Making

“…While often not possible to disentangle age from cohort effects, either decline in cognitive ability or low levels of knowledge among older cohorts was notable. Interestingly, this seems to mimic the findings of Agarwal et al (2009), which show a greater prevalence of financial mistakes among older individuals as well as less advantageous financial offers given to the elderly.…”

The role of cognitive abilities in decisions from experience: Age differences emerge as a function of choice set size

“…Yet, it is unclear to what extent cognitive aging is associated with declining levels of choice performance. The empirical results have been mixed, with some authors observing a profound decline in choice rationality (Agarwal, Driscoll, Gabaix, & Laibson, 2009;Boyle, Yu, Buchman, Laibson, & Bennett, 2011;Tymula et al, 2013) and others observing no decline relative to the decision-making performance of younger adults-or even improvement in specific tasks (Del Missier et al, 2013;Kovalchik et al, 2005;Li, Baldassi, Johnson, & Weber, 2013). Our findings revealed both: Instances of decisions from experience that were not substantially impaired by cognitive aging, and others that were.…”

Midlife as a pivotal period in the life course

“…Although those who are younger have faster cognitive processing, they lack the relevant experiences with financial choices. And those in later life, despite added years of experience, fall victim to the declines in executive functioning and working memory (Agarwal, Driscoll, Gabaix, & Laibson, 2009). Thus midlife, at the intersection of upward and downward cognitive trajectories, is at a particularly beneficial position in terms of a balance of strengths and limitations.…”