Older May Not Mean Wiser About Finances

As sure as the sun will rise in the east tomorrow, you'll become less smart about money as you age. But what's worse, according to researchers, is that your confidence with decisions about money will rise as you become less financially literate.

"We know that there are predictable declines in some of our decision-making abilities as we reach advanced age," said Michael Finke, a Texas Tech University professor and co-author of the study "Old Age and the Decline in Financial Literacy."

In his 2011 study, Finke and his co-authors found that knowledge of basic concepts essential to effective financial choice decline by about 2% each year after age 60, but confidence in financial decision-making abilities does not fall. Put another way: By age 90, you're half as smart about money as you were at age 60, but just as confident, if not more so. That can cause all sorts of financial problems.

"Increasing confidence and reduced abilities can explain poor credit and investment choices by older respondents," wrote Finke and his co-authors.

Others experts and research have found much the same, and suggest that you ought to take steps when you're young and are of sound mind to avoid poor and often irreversible decisions about complex investments and insurance that you might be encouraged to buy later in life.

Take a test or three

First, test your memory long before buying any investment or financial product, such as a variable annuity with guarantees, a deferred-income annuity or long-term care insurance.

Jack Marrion, president of Advantage Compendium, a St. Louis-based research and consulting firm, says one of the most accurate tests is the Blessed Orientation-Memory-Concentration (BOMC) test.

If you score 10 or above on the BOMC, consider asking a family member or trusted adviser to review whatever financial product or investment you're planning to buy before making any decisions. Weighted error scores greater than 10 can be consistent with dementia.

If you decide not to take cognition or memory tests, Marrion says there's another way to tell if you ought not buy financial products without the help of trusted advisers. "The last part on dementia is everyone forgets things, but we become more alarmed about forgetting as we age," he said. "Not remembering where the car keys are is normal; not remembering what car keys are for suggests a problem."

Marrion says investors with dementia don't have the legal capacity to enter into a contract. However, seniors with mild cognitive impairment may be able to make informed decisions, provided a financial professional has training in senior decision making.

Experts also recommend testing your financial knowledge. The National Financial Capability Study (NFCS), which was funded by the FINRA Investor Education Foundation, has one such test. Americans, on average, were able to correctly answer three of five questions about fundamental financial concepts, according to the FINRA Foundation.

"It does not matter that (the NFCS) is not precisely related to complex insurance products; people have to know the principles behind financial decision-making to make good decisions, including buying insurance products," said Annamaria Lusardi, academic director of the Global Center of Financial Literacy Excellence Center at the George Washington University School of Business.

Consider, too, the Financial Literacy Assessment Test (FLAT) created by Finke and his colleagues. The FLAT captures a respondent's self-reported level of confidence in each of four financial literacy content areas: basics, borrowing, investing and protecting. On average, those taking the FLAT get a score of 58%. More than half of those taking the FLAT (55%) consistently demonstrate they are financially illiterate.

Hire a fiduciary

Even if financial literacy or cognition and memory tests suggest you're still of sound mind, ask fiduciaries to vet any investments or insurance you're considering. Have them look at it from every angle: Does it make sense from a financial planning, estate planning, tax planning, risk management and investment point of view?

Also consider making your retirement plan while you're of sound mind. "The best advice is to do the heavy lifting early in retirement so that you can put your investments on autopilot later in life," said Finke. "Get a fiduciary financial adviser you can trust or build a retirement-income strategy that makes automatic payments."

Annuities can be a great choice, Finke says, but more complex products are often difficult for even academics to understand.

Others agree with the importance of knowing what you're buying before you sign on any dotted lines. "What I tell seniors is to take your time and spend most of that time getting to understand the downside of the decision," said Marrion, who wrote a report on the challenges created by cognitive declines in seniors for financial advisers. "How much can I lose, and how fast can I get my money if I need it? After you understand the cons, you can see if the pros offset them."

Robert Powell is editor of Retirement Weekly. E-mail him at rpowell@allthingsretirement.com