Financial Literacy and Decision Making over the Lifespan Ye Li , Martine Baldassi , Eric J. Johnson , Elke U. Weber Columbia University Center for Decision Sciences
Seniors in charge Is older actually wiser? 2
Why aren’t the older worse off? The older I grow, the more I distrust the familiar doctrine that age brings wisdom . - H.L. Mencken (1922) 3
Decisions about Health and Wealth ● Decumulation of assets is a complex dynamic programming problem. –Inputs include beliefs about longevity, market returns and inflation, future costs including health costs. –Annuitization involves similar complexities –Choice of health care insurance, both prescription drugs, and primary insurance ● A myriad of housing and health decisions. ● How can we structure these decisions to maximize abilities? 4
A concern for financial services firms. ● Older American (65+)s hold much in the way of assets: 34% of $53.1 trillion = $18.1 trillion (2007 Survey of Consumer Finances) ● But there is liability 5
Decisions relevant to Public Policy (Appelt et al. 2012) ● SSA retirement benefits are a primary source of income for over 50% of older Americans (SSA, 2010) ● 40-50% of Americans claim benefits as soon as they are eligible (Muldoon & Kopcke, 2008; Song & Manchester, 2007) ● 22% of consumers first think about the retirement decision only a year before they retire, and another 22% first think about it only six months before (EBRI 2008). 6
Fluid intelligence declines with age Changes with age… Fluid intelligence ( G f ) is the ability to generate and transform information on the fly - Seems critical for decision making! Fluid intelligence Salthouse, 2010
Yet, mixed results on decision making Changes with age… • Older adults are worse for some decisions… • Framing (Finucane et al 2005; Kim et al 2005) • Applying decision rules (Bruine de Bruin et al 2007) Fluid • Overconfidence (Crawford & Stankov 1996) • Risk Aversion (Dohmen et al 2011) intelligence …but sometimes no different from young… • Framing (Mayhorn et al 2002; Roennlund et al 2005) • Iowa Gambling Task and endowment effect (Kovalchik et al 2004) …and sometimes older adults are better ! • Sunk-cost fallacy (Strough et al 2008) Decision- • Attraction effect (Kim & Hasher 2005) making performance 8
Perhaps experience is compensating Changes with age… Crystallized intelligence ( G c ) is a stable depository Crystallized of knowledge acquired through culture, education, intelligence and life experience (Carroll, 1993; Cattell, 1971, 1987) Fluid intelligence Decision- making performance Salthouse, 2010 9
Compensating Cognitive Capabilities Hypothesis Indirect effect via G c Mediator G c a G c × b G c > 0 Positive mediation +a Gc +b Gc (Age is a benefit) c / c‘ (direct effect) Decision Age performance Observed effect a G f × b G f < 0 -a Gf +b Gf Negative mediation (Age is a detriment) Mediator G f Indirect effect via G f 10
Decision tasks with real-world economic consequences ● Financial Literacy (Lusardi & Mitchell, 2007) FL1. Imagine that the interest rate on your savings account was 1% per year DL1. Suppose you owe $1000 on your credit card and the interest rate and inflation was 2% per year. After 1 year, would you be able to buy more you are charged is 20% per year compounded annually. If you didn't pay than, exactly the same as, or less than today with the money in this account? anything off, at this interest rate, how many years would it take for the ● Ability to understand financial information and decisions – More than today amount you owe to double? – Exactly the same as today – 2 years – Less than today – Less than 5 years ● Debt Literacy (Lusardi & Tufano, 2009) – Do not know – More than 5 but less than 10 years – More than 10 years ● Ability to understand debt contracts and interest rates FL2. Do you think that buying a single company stock usually provides a – Do not know return that is more safe, equally safe, or less safe than the return on a stock DL2. You owe $3,000 on your credit card. You pay a minimum payment mutual fund? ● Temporal Discounting of $30 each month. At an Annual Percentage Rate of 12% (or 1% per – More safe return than a stock mutual fund month), how many years would it take to eliminate your credit card debt – Equally safe return as a stock mutual fund if you made no additional new charges? – Less safe return than a stock mutual fund ● Degree to which people discount future gains and losses – Less than 5 years – Do not know – Between 5 and 10 years ● Related to health (BMI, smoking) and wealth (savings, mortgage choice) – Between 10 and 15 years FL3. Is using money in a bank savings account to pay off credit card debt – Never, you will continue to be in debt usually a good or a bad idea? – Do not know – Good idea ● Loss Aversion – Bad idea DL3. You purchase an appliance which costs $1,000. To pay for this – Do not know appliance, you are given the following two options: a) pay 12 monthly ● Degree to which valuations of losses outweigh gains of the same magnitude installments of $100 each, b) borrow at a 20% annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer? ● Related to mental accounting, numerous investing mistakes, default effects – Option (A) – Option (B) – They are the same – Do not know 11
Cognitive measures • Raven’s Progressive Matrices (Raven, 1936; Salthouse, 2005) Fluid • Letter Series (adapted from Salthouse, 2005) intelligence • Number Series (McArdle & Woodcock, 2009) (HRS) (G f ) • Numeracy (Lipkus et al., 2001) • Cognitive Reflection Test [CRT] (Frederick et al., 2002) • Shipley’s Vocabulary (Shipley, 1986; adapted from CREATE) Crystallized • Antonym Vocabulary (Salthouse, 1993) intelligence (G c ) • WAIS – Information (Wechsler, 1997; adapted from CREATE) • Stroop (Stroop, 1935) (Lumosity Labs) Inhibitory • Flanker (Eriksen & Eriksen, 1974) (Lumosity Labs) control (IC) • Spatial 1-Back (Del Messier et al., 2010) (Lumosity Labs) 12
Sample characteristics • 336 participants • Center for Decision Sciences Virtual Lab database • No middle-age (30-59) Young (N = 173) Old (N = 163) 18 – 29 years 60 – 82 years mean = 24.8 years mean = 66.4 years 67% female 64% female • Four-wave online study (last wave 1 year later) • Same participants completed all four waves of the study • Dropout rates do not differ between young and old • No demographic, cognitive or decision-making variable predicts dropout 13
Decision-making traits FL Q1 FL Q2 FL Q3 DL Q1 DL Q2 DL Q3 .51*** .76*** .60*** .81*** .71*** .67*** .75*** Debt Financial Time 1 Literacy Literacy Time 2 (12 months later) Lambda $6a .63*** Discount $60, .48*** .39*** .25*** 4 months .07 .39*** Lambda $20a .90*** .64*** Discount $75, 3 months .62*** .55*** Lambda $6a Temporal Discount $55, Loss Aversion Discounting .11* 3 months .89*** .77*** Lambda $20b Discount $115, .87*** 3 months .72*** *** p < .01 Lambda $20 ** p < .05 Discount $100, (short) * p < .10 12 months f 14
Cognitive capabilities Gender (male) Education Income .18*** .15** -.07 .05 -.02 -.003 .33*** -.02 .12** .79*** Raven Synonym .71*** .67*** Numeracy .66*** .80*** G f G c Antonym CRT .73*** .54*** Numbers .67*** .59*** Letters Info .17 .34*** Inhibitory Control *** p < .01 .79*** .81*** .80*** ** p < .05 * p < .10 Spatial 1-back Stroop Flanker f 15
Structural Equation Model (SEM) G c Education Financial Literacy Age Debt Literacy 2 Income 3 Temporal Discounting 1 Inhib. control Loss Aversion Male G f f 16
Cognitive capabilities by age 1.5 Inhibitory control (IC) 1 Crystallized intelligence 0.5 (G c ) Z-Score 0 Fluid -0.5 intelligence (G f ) -1 -1.5 Young Old Salthouse 2004, 2010 17
Decision performance by age 1 Financial Literacy 0.75 Debt Literacy Discounting *** Loss Aversion 0.5 0.25 ** Z-Score * † 0 • Older are more financially literate -0.25 • Older are more debt literate -0.5 • Older are slightly more patient -0.75 • Older are slightly less loss averse -1 Young Old † p < .15; * p < .10; ** p < .05; *** p < .01 18
Financial Literacy Income Education ab gc = .24*** G c a gc = .41*** b gc = .59*** I δ = .12* E δ = .01 c direct = .65*** Age Financial Literacy c total = .41*** a IC = -.83*** b IC = .31* ab IC = -.26* m δ = .02 Inhib. b gf = .57*** a gf = -.40*** control Male *** p < .01 G f ** p < .05 * p < .10 ab gf = -.23*** 19
Debt Literacy Income Education ab gc = .24*** G c a gc = .41*** b gc = .58*** I δ = .03 E δ = -.13 c direct = .53*** Age Debt literacy c total = .19*** a IC = -.83*** b IC = .32* ab IC = -.26* m δ = .21** Inhib. b gf = .79** a gf = -.40*** control Male *** p < .01 G f ** p < .05 * p < .10 ab gf = -.32*** 20
Temporal Discounting Income Education ab gc = .08*** G c a gc = .41*** b gc = .20*** I δ = .13* E δ = .06 c direct = .11 Temporal discounting Age (more patient) c total = .08 a IC = -.83*** b IC = .04 ab IC = -.03 m δ = .04 Inhib. b gf = .20** a gf = -.40*** control Male *** p < .01 G f ** p < .05 * p < .10 ab gf = -.08** 21
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