All retirees should prepare for the inevitability of cognitive decline. While the average independent investor underperforms the market by 1.56%, the elderly are even more vulnerable to underperformance. Loss of prefrontal cortex processing skills decreases the ability to make analytical choices and regulate emotional responses. In effect, loss aversion, or people’s tendency to avoid losses over acquiring equivalent gains, increases with age. During the 2008 recession, the mean number of stock reallocations made by senior investors was considerably higher than that of middle-aged investors. Investors aged 55-59 sold stock to decrease their equity portfolios by 7.71%, while investors aged 80-84 decreased their stock portfolios by 12.12%.
Financial literacy is another casualty of prefrontal cortex aging. After peaking at age 49, financial literacy test scores decline, eventually decreasing by 1% annually after the age of 60. In contrast, confidence in financial decision-making ability has a slight upward trend from age 60 onward. This curvilinear relationship between age and ability is echoed in competence for various financial tasks. For example, individuals are least likely to misestimate their house value when applying for a home loan at age 50. Controlling for FICO score, individuals are least likely to pay a credit card late fee at 51.9 years, take out a credit card cash advance at 54.8 years, and get the lowest auto loan APR at 49.6 years.
