How Our Aging Brain Affects Our Financial Decisions

By Deborah O'Malley, M.Sc. and Melvin Pasternak, Ph.D.
November 29, 2011

You probably remember the Beatles' famous lament “Will you still need me, will you still feed me when I'm 64?" 

But the kind of anxiety many people experience about aging should extend beyond their love life and dinner plate. As a slew of recent academic research shows, the ability to make crisp, clear financial decisions declines as people get older.

In a May 2011 research report by David Laibson, Economics professor at Harvard University, claims that after age 60, our financial literacy and savvy declines -- no matter how well educated we are.

By age 80, nearly half the population suffers from cognitive deficits such as dementia that affect the ability to make sound financial decisions. Yet, paradoxically, as people age, their confidence in their financial decision-making ability increases.

At Texas Tech, Michael Finke designed a test to measure knowledge on investment, insurance and overall money basics necessary to make good financial decisions.

He found that at age 60 the average score was 59%. But this mark dropped to 30% for those 80 years or older, decreasing by about 2% for every year over 60.

This precarious mixture of decreasing cognitive function and increasing financial confidence makes aging brains vulnerable to false financial claims such as a website which says you can make hundreds of dollars a week working just a few hours part time from home. 

According to Natalie Denburg, a neurology and neuroscience professor at the University of Iowa, the reason the aging brain falls for these kind of schemes, is that it tells us to choose short-term benefits over long-term rewards.

For example, if an older person buys a couch, he or she may choose the "zero-money down" option to initially save money, even though they'll end up paying more in the long-term interest payments. 

Consider this fact: Approximately 34% of the $53.1 trillion of U.S. household net worth is held by people over 65. If you're approaching the golden years you should know that financial abuse of elderly Americans is on the rise. 

Since 2008, this kind of abuse has increased 12%, resulting in over $2.9 billion of annual losses, according to a June 2011 study released by the MetLife Mature Market Institute. And this percentage will likely only increase as baby boomers age.

[InvestingAnswers Feature: How to Protect Yourself from Today's Most Devastating Investment Scams]

So what can you do to help protect your financial assets in retirement?

Here are three specific steps you can take to circumvent your aging financial brain:

1. Set-Up a Retirement-Income Plan at the Right Time

Avoid making complex financial decisions later in life by setting up a financial plan that maps out your projected financial needs while you are still in your 60's. 

A well thought-out plan balances expected living expenses against anticipated income, from sources such as a pension or stock dividends. Adjustments will need to be made based on your expected income shortfall or surplus. 

As part of this plan, be sure to include possible nursing care costs since approximately 33% of Americans require long-term care at some point in their lives. This care can cost up to nearly $80 thousand per year. Consider long-term care insurance to deal with this kind of expenses. 

[InvestingAnswers Feature: Retirement Solutions: Avoid the 11 Pitfalls That Will Destroy Your Nest Egg]

2. Invest in Guaranteed Income

While your financial decision-making is still close to its peak, consider putting part of your nest egg into an annuity which will pay you a fixed income for life. Check with several different insurance and brokerage firms and carefully compare the terms you are offered.

A lifetime annuity also gives you the psychological benefit of knowing you'll have income as long as you live.

[Learn more about annuities with our simple guide: Annuities 101: A Lifetime of Income

#-ad_banner_2-#3. Appoint Someone You Trust to Manage Your Financial Decisions

If you have children nearby, consider designating one of them to make financial decisions for you before you feel your financial grip begins to slip. If you take this course, make them privy to your financial situation early on. 

Tell them how you’ve allocated your income and expenses and ensure they have access to your banking records. They’ll also need up-to-date contact information of your financial advisors, lawyers and accountants. 

While sharing this information may seem obvious, a 2010 survey by the Employee Benefit Research Institute (EBRI) found that only 47% of adults had in-depth financial conversations with their parents about their income and expenses. And, only 42% knew their parents' income information.

Make sure your children are "in the know" so they can manage the finances accordingly. If you don’t have children, choose a financial advisor you trust to help you manage your financial matters when you’re not able to do so.

[Be sure your advisor is looking out for your best interests: 5 Ways to Keep Your Broker Honest]

The Investing Answer: Like many of the unpleasant facts of life, the decline of financial prowess as we age is one most people would rather deny. But the first step to effectively deal with this reality is to move from denial to acknowledgement. 

By coming to terms with this aspect of aging, you can start to take the steps to properly plan. By proactively taking control of your financial situation well in advance, you can confidently enjoy your retirement as you age.