Michael Guillemette, an assistant professor of personal financial planning in the University of Missouri’s College of Human Environmental Sciences, has published a new paper that should give financial advisers a moment’s pause.
The paper cites data from Pew Research to show there were 75.4 million Baby Boomers living in the United States, as of year-end 2014. As this generation continues to age, Guillemette says dialogue will necessarily have to increase between advisers and clients on how to manage concerns associated with aging, “such as the decline in cognitive ability and retirement decisions.”
Guillemette’s research suggests older individuals with lower cognitive abilities “are susceptible to behavioral biases, such as being adverse to upfront costs.” He notes that risk aversion, along with lower cognitive ability among older Americans, might even explain the lack of demand for certain retirement savings products—especially those with a high up-front cost relative to the overall value of the product.
“Some financial products, such as annuities, have upfront costs,” Guillemette explains. “With a pure-life annuity, an individual will pay an upfront cost that is typically $50,000 or higher and in exchange will receive monthly payments for life. The risk associated with annuities comes from the uncertainty of death. If the full amount of the annuity is not paid out prior to the death of the recipient, the money is lost. In our study, an upfront cost caused people with lower cognitive abilities to shy away from future risky decisions.” (Also see “Income Planning Requires Annuity Know-How.”)
Guillemette says he has worked with co-authors Chris Browning and Patrick Payne, from Texas Tech University, to measure plan participants’ cognitive function by “evaluating respondents’ working memory and numeracy.” The analysis considered two hypothetical risky financial prospects, both with equivalent expected returns, but one situation included an upfront cost and the other had no upfront cost.
“Results from the study show that individuals with lower cognitive ability exposed to the perceived upfront cost were less willing to take subsequent risk,” Guillemette says. “Results from the study might help explain the low demand for annuity products among older Americans. The results might also explain why companies choose to break up upfront costs in order to increase sales. For example, a large phone company now has a program where you pay for the full cost of the phone over several years.”
The full study was published in Applied Economics Letters, and a short summary published by University of Missouri is here.