How to Protect Your Money From Poor Decisions Due to Cognitive Decline

At 80 You Won't Have the Same Decision Making Abilities That You Have Today

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An older you could make dangerous financial decisions. Gary Waters/Ikon Images/Getty Images

In his early 70s, recently divorced and diagnosed with terminal cancer, one of my clients withdrew over $90,000 in his last year of life. Considering the circumstances, we did not think that was so unusual until we got a call from his son a few weeks after dad's death.

While at his dad's home sorting through belongings, the phone rang. The son answered the phone, and the lady on the line wanted to know where her promised money was.

As the son started digging, trying to figure out who this lady was and what dad had been up to, he found a stack of money order receipts, all for money given to random strangers dad had found on the internet. The total? Over $90,000.

What possessed this man to start giving away his money to random strangers?  Although no one can determine exactly what motivated dad’s decisions, what likely happened is that he experienced the normal decline in cognition and financial literacy that most of us humans will experience as we age. This decline begins at about age 60.

In the 2011 research paper,​ Old Age and the Decline in Financial Literacy, Michael Finke, John S. Howe and Sandra Huston explored this topic by measuring the degree to which knowledge of basic concepts essential to effective financial choice declines after age 60. They concluded,

"Consistent with prior studies of cognitive decline in old age, we find that financial literacy scores decline by about one percentage point each year after age 60.... When age is sorted into 5-year groups, respondents age 70-74 have significantly lower financial literacy scores than respondents age 60-64."

While financial literacy (meaning having the ability to apply knowledge correctly in the financial decision-making process) is declining, our confidence in our abilities remains high. The Finke/Howe/Huston paper goes on to say,

"Confidence in financial decision making abilities does not decline with age. The likelihood of being overconfident with one’s financial knowledge increases with age. Each year of age after 60 increases the likelihood of having high confidence and low financial literacy scores by 7 percent."

This is consistent with the results of 2015 study by The Center for Retirement Research at Boston College, How Does Aging Affect Financial Decision Making?, which found,

 “that large declines in cognition and financial literacy have little effect on an elderly individual’s confidence in their financial knowledge, and essentially no effect on their confidence in managing their finances."

If you're retired, or soon to be retired, this should be of concern to you. In the field of behavioral finance, overconfidence is a known factor in poor financial decision making. The Center for Retirement Research study goes on to say,

"Perhaps not surprisingly then, more than half of those experiencing a significant cognitive decline retain primary responsibility for managing their finances."

What are the possible consequences of making financial decisions with cognitive abilities on the decline? The Center for Retirement Research concludes,

"Given the increasing dependence of retirees on 401(k)/IRA savings, cognitive decline will likely have an increasingly significant adverse effect on the well-being of the elderly.”

The Finke/Howe/Huston paper quotes prior research which agrees,

"Cognitive ability, and in particular mathematical skills of the primary financial decision maker, is a strong predictor of the ability to avoid depleting net worth in later life (Smith, McArdle and Willis, 2011) and in making fewer financial mistakes (Agarwal and Mazumder, 2013).... For example, Korniotis and Kumar (2011) show a decrease in investment performance that mirrors observed declines in cognitive ability by age. Our study shows that the decline in performance may be attributed directly to an age-related decrease in financial knowledge and the ability to apply knowledge correctly to financial decision-making."

What can you do about this? The first step is to be aware of it. Unfortunately, we are often in denial of our own changing abilities. Yet research shows those aware of the problem may take positive action. Finke/Howe/Huston say,

"Among the aged within similar decision-making domains, there is an inclination to reject evidence of declining mental abilities. For example, older drivers generally do not perceive a decline in their driving skills despite a predictable deterioration in sensory ability with advanced age (Holland and Rabbitt, 1992). However, they report that those who did perceive a decline in their abilities, and those who took an objective test that provided evidence of a decline, modify their driving behavior to reduce the likelihood of getting into an accident."

If you take action in advance you can protect your wealth from less effective decisions that the future you may make.

Finke/Howe/Huston conclude,

"A decline in financial skills may not lead to poor financial outcomes if individuals recognize and anticipate the decline. For example, recognition of diminished investment skills may increase demand for annuitization or the delegation of important financial decisions to a trusted advisor."

The best time to take action is in your 50's and 60's while your cognitive abilities are peaking. This is the time to make an action plan that the older you can follow. That action plan should likely involve finding advisors younger than you.

And simply finding an advisor isn't enough. You want an advisor who has a legal obligation to act in your best interests (no, not all advisors have this fiduciary obligation to you).

You also need to develop a written action plan with your advisors and/or family members so they know what to do if they begin to observe financial behaviors that don't seem to be in your best interest. Is there a family member or medical professional you would want your advisors to contact? If so, provide them with permission to do so in writing.

Another thing you can do: reach out to older family members. Stay involved. Make them stay involved with you. Visit them regularly. Find time to have ​a casual conversation with them so you know what their interests are and what they do with their time. Find out if they have any new hobbies (such as an internet chat room) or any new friends they see regularly.

Make sure they have made arrangements so that should a medical emergency occur someone would be able to pay their bills and manage their affairs. And realize they are likely to say they are just fine and don't need your assistance (overconfidence). Also realize if you don't put plans in place now, that obstinate person could be you in twenty years.