There has been a social policy shift regarding the responsibility for managing retirement savings. Unfortunately, this shift often occurs at the precise time of cognitive decline-related underperformance. Financial advisors need to be aware that a client may be at an age when they are no longer capable of meeting the responsibility of managing their financial future.

According to a recent study, Old Age and the Decline in Investment Performance,¹ age-related cognitive decline adversely affects a retiree’s ability to manage a portfolio in later life, beginning as soon as the early 60s.

Perhaps more dangerously, the level of financial self-confidence a retiree has remains the same—or increases—through retirement until eventually dipping upon reaching age 90.

What Advisors Need to Know

Past research has found that financial literacy peaks in middle age and begins declining at a rate of about 1.5% per year after the age of 70. The study’s authors argue that it is this gradual decline, and its imperceptibility, that explains why older retirees remain financially self-confident despite their eroding capabilities.

This cognitive decline affects individuals of all wealth strata.

Cognitive decline manifests itself in degraded investment performance through lower quality security selection and poor market timing. This underperformance is material; investors over the age of 75 experience, on average, 300 bps lower returns than middle-age investors, with the performance disparity actually higher—500 bps—among older investors with greater wealth.

One example of how poor market timing has hurt older investors can be found in the Credit Crisis years. While investors in their 40s were as likely to buy stocks as to sell them during the months of September to November 2008, the degree of selling was increasingly higher with each successive older age group.

For older investors, more than any other cohort, their stated risk tolerance rose with rising equity markets and fell in tandem with falling markets—a recipe for investment underperformance. Their investment decisions become based more on emotions as their memory and ability to process new information declined.

How Advisors Can Help

Financial advisors can play an important role in helping older investors avoid cognitive decline-related underperformance. Moving older retirees into professionally-managed asset programs is an effective way to shift the investment responsibility away from an aging investor to a professional manager. Another idea is to develop a retirement income strategy that relies more on predictable income so that retirees can feel more secure during down market cycles.

Source:

1.https://poseidon01.ssrn.com/delivery.php?ID=284123064090005013102083126105097065040086057015091007085093116078112071011006087069106114044017059048002099030112115106028085060078047087052017066007092124116053022002104030028082068126086011114100071015117069019101120110108081093090094064093024&EXT=pdf

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