Wednesday, March 7, 2012

Decision Making in Geezerhood

The waitress returned for the third time, order pad in hand.  "How we doin' here folks?  Are you guys ready to order or would you like another few minutes?"  There was a tone of sweet condescension in her voice, likely the result of her reaction to our grey hair.  I imagine she was thinking: come on geezers, make up your minds!

One of the stereotypes of older people is that they have difficulty making decisions and the decisions they finally come up with are often flawed.  Like most stereotypes, this one has a kernel of truth but also distorts the real picture, and is flat-out wrong in certain cases.  For instance, my wife and I have always taken a long time to order in a restaurant because we share each dish and we are both particular -- so it takes some time to select things we both will like.  Being geezers is irrelevant.

However, there is ample evidence from research on aging that the average performance of older people on many types of decisions is both slower and less optimal than younger people.  This is particularly true when the decision involves remembering, evaluating, and comparing many pieces of information that vary in relevance to making an optimal choice.  The cognitive declines in memory, analytic reasoning, and executive functioning that are common in older adults make these kinds of decisions more difficult and results in sub-optimal choices (Henninger, Madden, and Huettel, 2010).

Financial decision-making is one realm in which the consequences of poor choices can be very important. The cognitive deficits associated with aging have been found to be particularly problematic in this context. For example, a Brookings Institute study comparing age groups on a variety of financial products found that older people wind up paying higher fees, penalties, and interest rates across a wide range of credit transactions, including credit cards, mortgages, and car loans (Agarwal et al., 2007).  Interestingly, the relationship between decision quality appears to be U-shaped, with the most optimal decisions made by those around 50.  One explanation of this curvilinear function is that young people, though they have high cognitive abilities lack experience and background knowledge, whereas older people have a great deal of experience and knowledge but have difficulty applying this because of cognitive deficits.  In middle age there is an optimal trade-off of experience and cognitive functioning.

Another important aspect of financial decision-making involves making choices that require an assessment of risk of loss versus probability of reward.  For example, maintaining an investment portfolio of 100% bonds entails very little risk but provides limited rewards, whereas a portfolio of 100% equities entails much more risk but also may provide significantly greater returns over time.  And of course there is considerable variation in the risk levels of individual stocks and bonds that requires evaluation and comparison of complex information in order to make an optimal choice.

Unfortunately, research evidence concerning the quality of decisions involving risk indicates that geezers tend to make poorer decisions than young people.  Henninger et al.(2010) recently summarized the data succinctly:
...older adults’ real-world decisions involving risk are often of objectively worse quality than those of younger adults, both in laboratory and real-world settings, with an abrupt decrease in decision-making skill observed in individuals over 70 years of age (Korniotis & Kumar, in press). As examples, older adults within that age range earn 3%–5% lower risk-adjusted annual returns (Korniotis & Kumar, in press) and obtain systematically worse outcomes on a wide variety of financial instruments (Agarwal, Driscoll, Gabaix, & Laibson, 2007), even when controlling for confounding factors like income, investment horizon, and desired rate of return... In short, substantial evidence demonstrates that older adults are more likely to make poor-quality financial decisions, often leading to significant negative personal consequences.
In line with the "conservative geezer" stereotype, one source of these sub-optimal decisions might seem to be a general tendency toward risk aversion even when some degree of risk is adaptive. However, the evidence indicates a more complex picture. Though older people do exhibit detrimental risk aversion in some circumstances (Mather, 2006), they also may show the same or even more risk preference as young people in other situations.  For example, if the benefits of an alternative with more risk are emphasized, older adults may weigh them more heavily than young people.  This stems from the general tendency of older people to be more optimistic and positive than younger people, a phenomenon I explored in an earlier blog.  In the financial arena this tendency may lead to poorer choices and susceptibility to scammers (Ross, 2010).

So far the picture looks pretty bleak, but fortunately I can end on a couple of positive notes.  First, recognizing the challenges of geezer decision-making allows the development of ways of presenting information modifying the context of decision making to compensate for declines in cognitive functioning, for example by reducing the memory load in decision tasks and by presenting information in ways that can be more readily related to older adults' greater past experience (Henninger et al., 2010) and that may more clearly balance the positive and negative aspects of risk alternatives (Ross, 2010).

Second, it is clear that there is considerable variability in the quality of decision-making by geezers, to the degree that some older people outperform younger adults.  This variability has been shown to be tied to differences among older people in the degree of cognitive decline -- an important fact because it means that it isn't age per se that leads to poorer decisions but rather it is the degree of specific types of neurological deficit.  And there is abundant evidence that the rate and amount of cognitive decline can be altered by life style choices, with the most dramatic effects coming from continuing physical exercise throughout middle and old age (see my blog Jogging the Memory of a Geezer for a review of this research).

Yet another reason to lace up those walking shoes -- it might keep you solvent!

Agarwal, S., Driscoll, J., Gabaix, X., & Laibson, D. (2009). The age of reason:  Financial decisions over the life-cycle and implications for regulation.  Brookings Papers on Economic Activity, 2, 51-117.

Henninger, D.E., Madden, D., & Huettel, S.A., (2010). Processing Speed and Memory Mediate Age-Related Differences in Decision Making. Psychology and Aging, 25, No. 2, 262–270.

Mather, M. (2006). A review of decision-making processes: Weighing the risks and benefits of aging. In L. L. Carstensen & C. R. Hartel (Eds.), When I’m 64 (pp. 145–173). Washington, DC: National Academies


Unknown said...

Thinking Fast and Slow (Daniel Kahneman) addresses many of the probability (and financial) errors people, even those familiar with statistics, commonly make. Not an easy read, but worth the effort.
Don Parker

Unknown said...

Don Parker