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Dispatches

How Investing Ability Changes With Age

Emerging research on cognitive aging as well as many financial studies have found declines in financial capability and concurrent lower investment performance among older individuals.

by AAII Staff | July 2020

 

Emerging research on cognitive aging as well as many financial studies have found declines in financial capability and concurrent lower investment performance among older individuals.

This is concerning due to the shift from defined-benefit pensions to defined-contribution plans, such as 401(k) plans, which places the welfare of retirees increasingly on their ability to make sound financial decisions.

Investors age 75 and above experience “much lower returns than younger investors.” The relationship between age and risk-adjusted investment performance shows the pattern of returns being lower among young investors, improving up to age 42 where it peaks and then declining after age 70 sharply.

Investors older than 75 on average experience investment returns that are 3% lower than those of middle-age investors. This return disparity rises to 5% among older investors with greater wealth. A mix of overconfidence and reduced abilities explained the subpar investment choices made by older subjects. Notably, in the study, financial literacy scores declined by about 1% each year after age 60, but subjects’ confidence in their own decision-making did not decline with age.

The authors of the study also noted that older workers are far more likely than younger workers to exhibit risk-tolerant investment preferences following a rising stock market, and risk-averse preferences following a decline in the market. By preferring risky assets after stocks rise in value and safe assets after stocks have declined in value, older investors exhibit poor market timing.

One explanation for these behaviors was that lower-quality decisions arise when either probabilities or outcomes are far from reality. Aging may compromise both an investor’s ability to process information in order to form accurate estimates of either investment probabilities or outcomes as well as the emotional response to an anticipated or realized loss.

The study’s authors conclude that “in the absence of widespread use of investment defaults, the observed underperformance of older investors in equity markets raises the possibility that stocks should be underweighted in the portfolios of self-directed retirees. The emotional response to a significant wealth decline from a stock market crash can impact retirees beyond the loss of their financial resources.”

Source: “Old Age and the Decline in Investment Performance,” by Michael S. Finke and Sandra J. Huston; Max Planck Institute and Bank of Italy Behavioral Financial Regulation and Policy Workshop, May 2020.

Discussion

Bob M from MA posted over 6 years ago:

I was quite interested in your dispatch article of July 2020 that described research on investing ability changing with age. They were some good points but I wonder about the observation that people who are older or have 3% less return on their investment... Rather than simply attributing this to decreased investment acuity, I think it is important to consider the possibility that as people get older they have more conservative portfolios which might naturally have a lower return on their investments.


THOMAS S from MN posted over 6 years ago:

I might suggest that the authors have reached their conclusions in reverse. As investors age, they typically reduce their security holdings and add more fixed income assets for capital preservation. Thus returns reduce by two factors: (1) lower exposure to securities and (2) reduced income from fixed income assets as interest rates have decreased. Thus, returns decrease as one ages due to changing investment decisions, not due to cognitive decline. Tom S from MN


HAROLD S from VA posted over 6 years ago:

I concur with the 2 prior commenters. It reflects my experience since about age 72. Now at 85 I am more focused on stability and income, not growing the portfolio. I filled my portfolio with securities that have a strong record of paying mid-range dividends. I don’t worry about the fluctuation in indexes or the price of individual securities. Unless there is a fundamental change in the condition of a specific holding I simply sit tight and continue collecting my dividends while urging my grandchildren to do the same.


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