As investors age, the ticking clock can take a mental toll. Harvard economics professor David Laibson recently shared his insight on how age-related cognitive decline can affect investors, and how investment firms should respond.

“People in their 70s tend to have low default rates and excellent credit, yet they pay terrible interest rates on credit cards and mortgages,” says David Laibson, the Robert I. Goldman Professor of Economics at Harvard University. “The reason is that many older people aren’t sophisticated bargainers, they don’t
understand the system, and they accepted the first interest rate offered to them. If they’re getting a raw deal when taking out a mortgage, can you imagine what could happen when buying an annuity or investing their financial assets?”

Laibson blames the poor choices of older people on a very common decline in cognitive abilities.

“As we age, some things improve and some things don’t. Wisdom seems to rise with age. But fluid intelligence – the ability to handle abstract problems –
declines after age 20. These two factors move in opposite directions, with the optimal balance generally occurring in mid-life. That’s why you see people in their 50s paying the lowest interest rates and earning the highest risk-adjusted returns.”

But Laibson says mental difficulties can become evident after age 60, and half of us will have either marked cognitive decline or full-on dementia by age 80.

“This is not a small minority of adults,” he warns. “We all have a great likelihood of facing this problem at some point, and that’s why we need to get our affairs in order well in advance.”

A new financial planning imperative

Laibson believes everyone should have four types of documentation in place by their 50s, if not sooner:

1. An up-to-date Will

2. A durable Power of Attorney for financial matters

3. A Living Irrevocable Trust if there are considerable assets

4. A Living Will regarding medical care

“As we get older, we need more protection, whether it’s from the financial consequences of having a stroke or falling prey to a Ponzi scheme. Advisors should help their clients fill out these forms and get their representatives and beneficiaries in place. In fact, I believe this should be standard operating procedure at every planning firm.”

Our view

Firms that adopt professor Laibson’s recommendations have a huge opportunity to earn valuable “trusted advisor” status while also doing the right thing for their clients. We think that’s a true win-win situation.