Does Overconfidence Increase Financial Risk Taking in Older Age?

Sep 25, 2020 / Amanda Chase, Horsesmouth Assistant Editor

Using data from the Rush Memory and Aging Project, this research provides new and updated evidence that overconfidence in financial knowledge may lead to excessive financial risk taking in older age. Older adults manage an increasing share of national wealth in the United States and other graying nations. Risky decisions by aging investors may have effects on financial markets in general but certainly have critical effects on the longterm health and well-being of the individual decision maker. Taking excessive financial risk in older age can be devastating as opportunities to recover lost wealth are limited as an individual ages.

Financial literacy (a measure of both financial knowledge and numerical ability) was similar among sixty- and seventy-year-olds but was lower in eighty-year-olds and even lower in ninety-year-olds. Confidence levels were slightly lower in the oldest adults but the correlation of age and confidence was very weak. Unlike the curvilinear effect of age on literacy, age differences in confidence were linear but the differences were small.

The low levels of financial literacy in the oldest adults combined with minimal age differences in confidence might contribute to higher levels of overconfidence in the oldest age group. We computed an overconfidence score by subtracting literacy levels from confidence ratings. Initial analysis of the data suggested a small increase in overconfidence in the oldest adults but after controlling for literacy levels the difference was not significant. The small age difference in overconfidence was due primarily to the age differences in literacy.

Although financial overconfidence was not strongly associated with age, overconfidence was positively correlated with financial risk tolerance. Individuals with the highest overconfidence scores (higher scores mean higher confidence than literacy) reported being more willing to take financial risks in their lives. This pattern emerged across everyone in the data set and also within subgroups of adults who varied in cognitive status. Older adults with no cognitive impairment showed the same positive correlation between overconfidence and risk tolerance as did the older adults with mild cognitive impairment.

You can find the full summary of the FINRA Investor Education Foundation paper here.

 

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