Age Differences in Financial Decision Making: The Benefits of Experience and Emotions
How does aging affect financial decision making? A new study shows that older people tend to have fewer negative emotions when it comes to financial decisions and this can contribute positively to decision outcomes.
As the population is aging, pension systems are changing and the financial services landscape is growing more and more complex, researchers have become increasingly interested in studying the relationship between aging and financial decision making, including the cognitive and noncognitive factors that may contribute to these outcomes.
Cognitive processes are mental processes that rely on conscious effort, such as multiplying 14 by 12. Processes that do not require conscious mental effort, but depend on attitudes, emotions or motivations, are called noncognitive factors.
Research generally suggests that older individuals struggle with decisions that place high cognitive demands, but they may benefit from knowledge accumulated with experience. A newly published open access article in the Journal of Behavioral Decision Making by Wiebke Eberhardt and her colleagues looks at age differences in financial decisions by taking into account such cognitive factors, along with noncognitive factors in the form of negative emotions and motivation.
To capture cognitive factors, the study quizzed participants about their numeracy, experience with various financial products and financial literacy. Noncognitive variables included a measure of self-reported negative emotions when making financial decisions (e.g. being upset, nervous or ashamed), along with a ‘need for cognition’ variable (the extent to which people prefer to put effort into their thinking processes).
Financial decision making, the outcome of interest to researchers, was measured in different ways.
First, they looked into the extent to which individuals are susceptible to sunk costs. For example, research participants had to imagine they were at a hotel and had already paid to watch a pay TV movie, upon discovering a more interesting movie on free cable TV. They were then asked to indicate the likelihood on a scale of watching pay TV (high sunk cost bias) versus free cable (low sunk cost bias).
Second, individuals were presented with credit card repayment scenarios with different payment budgets, balances and APRs. Researchers measured the extent to which participants made optimal decisions.
A third area of interest in the study included participants’ self-reported money management behaviors, such as staying within their budget or saving for the short to long term. They also asked about negative financial decision outcomes, such as late bill payments or bounced checks.
Research results indicate that age leads to reduced sunk cost bias and fewer credit card mistakes. Interestingly, money management generally improves with age, but dips among people in their 40s. Financial decision outcomes also improve with age, but decline in later life (60s and beyond). As expected, the study finds that age is associated with better outcomes in most domains due to older people’s experience-based knowledge.
The study also shows that noncognitive factors (motivations and favorable emotions) are associated with better money management and financial decision outcomes, regardless of cognitive factors (experience-based knowledge and numeracy). With respect to emotions and decision outcomes more specifically, growing older leads to fewer negative emotions in financial decisions, which in turn fosters good financial decision outcomes.