Experience, knowledge and expertise can compensate for the challenges that age-related deterioration present in finance, according to new research from Columbia Business School.

“Sound Credit Scores and Financial Decisions Despite Cognitive Aging,” recently published in Proceedings of the National Academy of Sciences, found evidence that what the researchers call crystallized intelligence, which is gained through experience and accumulated knowledge, can be more important to financial success than fluid intelligence, the ability to think logically and process new information.

The results have important implications for public policy and for designing effective tools and interventions to help those age 65 and older with complex financial decisions, the authors say.

According to projections from the U.S. Census Bureau, the number of Americans age 65 and older will more than double by the year 2050. The rise of defined contribution (DC) plans puts more complex decisions in the hands of individuals, and those 65 and older may find these financial decisions increasingly challenging.

Cognitive decline is real, but does not spell doom for making financial choices, says Eric Johnson, the Norman Eig Professor of Business at Columbia Business School and co-author of the study. “An alternative route to making sound financial decisions comes from experience—and that improves with age,” Johnson said.

Crystallized intelligence may function as a kind of intellectual capital that provides an alternate roadway to sound decisions, the study suggests. To illustrate how this may work, the researchers use the example of an immigrant in a new country, shopping for the first time, confronted by new brands sold for prices in an unfamiliar currency.

By contrast, an experienced shopper—who knows which brands are better, which prices are lower and where favorite brands are located—has an accumulation of knowledge and expertise that greatly reduces the need for information processing and active search. In much the same way, the researchers theorized that older adults, with a greater store of crystallized intelligence, would be able to create an alternative route to good decisionmaking when their store of fluid intelligence has dipped.

To test this, they created a database that combined multiple measures of cognitive ability, economic preference and personality traits with field observations of economic performance from credit reports and environmental assessments of realistic financial decisions.

The More You Know…

The dataset allowed researchers to test whether the two types of intelligence relate to financial performance and how age differences in these abilities relate to difference in financial performance. This allowed them to test a framework that describes age-related differences in decisionmaking ability by using real-world financial outcomes: namely, credit scores.

The research found that credit scores related positively to both fluid intelligence and financial literacy, and that higher levels of financial knowledge and expertise provide a distinct and alternate route to sound financial decisionmaking for older adults whose fluid intelligence is less available. One reason could be older adults’ longer financial histories and greater experience using financial products.

Using the effect of age alone on decisionmaking can yield misleading results, Johnson said. “Policymakers and future researchers should also examine the distinct roles of decreasing cognitive abilities and increasing—but eventually plateauing—domain-specific knowledge and expertise when developing tools for the aging population,” he said.

The researchers believe that age-specific decision aids and interventions that build on conduits to good decisions will not only produce better outcomes for older individuals, but reduce potentially large costs to society.

“With the proliferation of self-directed benefit plans and the demise of traditional pensions, those who have accumulated wealth over their lifetime face even greater challenges and more responsibility when managing their finances than the older population of previous generations,” said Elke Weber, the Jerome A. Chazen Professor of International Business at Columbia Business School and co-author of the study. “One way to improve financial decisions across lifespan is to reduce the reliance on fluid intelligence by limiting decision options, or allowing decisionmakers to sort options.”

The study is co-authored by Ye Li, of the University of California at Riverside School of Business Administration; and Jie Gao, A. Zeynep Enkavi and Lisa Zaval, all at Columbia University. The four-part, Web-based study assessed the cognitive ability and economic preferences of 478 U.S. residents between the ages of 18 and 86, using a battery of cognitive, decisionmaking, and demographic measures.

Researchers leveraged a unique data set combining measures of cognitive ability and knowledge with credit scores, a measure of creditworthiness that reflects sustained ability for sound financial decisionmaking. This dataset allowed researchers to explore whether knowledge and expertise accumulated from past decisions could offset age-related declines in cognitive ability.

More about the research being conducted at Columbia Business School is at www.gsb.columbia.edu.