How does your ability to make financial decisions change over time?

One research study suggests that, across the population, financial skill follows a hump-shaped pattern. In our youth, we start with low levels of financial knowledge. Over time, our ability grows through experience. However, as we age, our cognitive faculties begin to decline. Over time, the decline in ability outpaces the growth in experience, and as a result our net ability falls. Hence the idea of a hump-shaped curve: from a low in youth, to a peak in middle age, to a slope downward in our older years.

What’s the magic turning point? The researchers estimate age 53 as the age of peak financial decision-making. Coincidentally, I just turned 52—and so if I am like the study averages, I can anticipate another year of strong financial decision-making, followed by a slow but inexorable decline.

This question of cognitive skills is one of the more vexing questions we face in an aging society. Of course, there will always be a large cadre of older individuals who are able to make informed financial decisions on their own. Yet there is an expanding group of older adults unable to comprehend all of the details needed to purchase modern financial products. As the researchers note, the prevalence of dementia doubles every five years after age 60. What’s more, older decision-makers are affected by milder cognitive difficulties not associated with a formal dementia diagnosis.

At a social level, it’s hard to imagine what the path forward is on this issue. Do we create a set of ultra-simple financial products through regulation? But not everyone is impaired, and some households will want to use sophisticated financial tools. Do we require everyone to complete a questionnaire about his or her skills before buying complex products? That’s hard to administer—and hardly fair if it targets only older decision-makers. Do we impose higher standards of conduct in the case of impaired decision-makers? But then how do financial providers know who is impaired, and isn’t?

Whatever solutions emerge, the question of cognitive skills is not going away, especially in a globally aging world. The financial world is only growing in complexity. Think about the financial decisions that older households face in terms of loans and credit, investments, insurance, reverse mortgages, supplemental health insurance, and so on. (And it’s not just the financial world—have you bought a new car lately?) If that complexity poses a challenge for inexperienced young decision-makers, it is certain to prove daunting for older households struggling to make informed choices.

Note: The link contained in this blog post will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.