By Tom Sightings
Do you get smarter as you get older, or does time slowly erode your cognitive abilities? A recent study from the University of California at Riverside and Columbia University, with the mind-bending title "Complementary Cognitive Capabilities, Economic Decision Making and Aging", has the answer.
Researchers tested a group of 20-somethings and people in their 60s and 70s in various financial subjects such as basic financial literacy, knowledge about debt, tolerance for risk and how much the participants thought about their financial futures. Despite a general loss of mental acuity, the older group did better than the younger test-takers in virtually every category. How is that?
The researchers explained the results by teasing apart two different kinds of intelligence. Fluid intelligence involves short-term memory, problem solving and the ability to manipulate information and process it quickly. Crystallized intelligence consists of a "stable repository of knowledge acquired through experiences, culture and education."
As we age, we lose fluid intelligence, but gain crystallized intelligence. "For decisions that rely heavily on processing new information, it is likely that the negative effects of aging will outweigh its positive effects relatively early in middle age," the study concludes. "On the other hand, if the decision relies on recognizing previously learned patterns in a stable environment, age may be an advantage."
It turns out that for most financial decisions it's better to rely on knowledge, experience and "previously learned patterns" than it is to exhibit an ability to quickly process new information. There are five areas, in particular, where older people outshine their younger counterparts:
1. Retirees demonstrate a better understanding of finance and debt. Perhaps older people can't solve an equation quite as fast as their sons and daughters. But a greater knowledge about assets, loans and interest rates leads older people to make better decisions in the real world. They are more likely to save and invest in the first place, then make better financial decisions such as choosing mutual funds with low fees. They also avoid high-cost borrowing, such as taking out payday loans or carrying credit card balances, and they are wary of incurring other financial costs, such as high bank fees.
2. Older people have more control over their emotions. They are less likely to buy at the top, then panic and sell at the bottom. They are more skeptical about jumping on the latest investment trend or buying on a hot tip, which is almost always a mistake. Older people are less likely to get sucked into a financial bubble that is about to burst. Who suffered the most during the housing bubble of the late 2000s? Not retirees, but first-time buyers.
3. They are better at avoiding irrelevant information. Most older investors have the ability to tune out the noise from CNBC and other financial media, which focuses too much attention on the news of the day, especially when the news is not even that relevant to your investments. The latest pronouncement from the Fed or impasse in Washington can get everyone excited, but older investors know that while today is stormy, the sun may come out tomorrow or vice versa.
4. Older investors have a sense of their own limitations. Young people can be cocky, overconfident and convinced they are always right. Their older brethren have gone through some bitter experiences, and know that sometimes forecasts don't pan out. And there is no more important quality in a good investor than a bit of humility. Experienced investors know the frustration of hoping that a losing investment will somehow make a comeback, when all the evidence says it will not. They have the discipline to take a small loss now rather than wait around for a complete catastrophe.
5. Seniors are more patient. They are more able to weather the ups and downs of the market, without panicking and changing their minds with every twist of the financial wind. Younger people who can process information more quickly may make better day traders, but day traders almost always lose money. People who are slowly building up wealth over time in a considered and strategic way know that the experience and accumulated knowledge of a seasoned investor will win out in the end.