An article in The Wall Street Journal caught my attention recently. It talked about how Americans, regardless of gender or education, become considerably less literate about all things money after age 60.
You see, humans are all the same everywhere. So what applies to Americans, also applies to Indians.
Anyways, the above conclusion was based on a test conducted by Michael Finke, an associate professor from Texas University.
The scores on a test measuring knowledge of investments, insurance, and money basics fell about 2% each year starting after age 60, falling from about 59% correct for those in their 60s to a dismal 30% for those 80 and older.
What was even a worse output of the study was that our confidence in our financial decision-making abilities rises with age.
So, we are not older and wiser. Instead, as we age, we become less smart and more confident about financial decision-making (I’m sorry to say but this is what the research suggests)!
I believe this very notion of overconfidence rising while financial literacy is falling spells trouble for most investors as they age (excluding someone like Warren Buffett).
Mr. Finke and his team also noticed that financial literacy peaks around 45 years of age.
In simple words, your ability to make the right financial decisions starts to decline after you cross 45.
I am not saying that this is true for each and every person near or above the age of 45, but then it seems true for a majority, as the abovementioned study has found.
“Oops, I’m already above 45!”
If you are nearing or already above 45 years of age, what should you do to ensure that you are able to cover up for your declining ability to make the right financial decisions?
First, acknowledge that your ability to make financial decisions will decline as you grow older, even while your confidence will rise. And know that this is a dangerous combination.
Don’t think this won’t happen to you, because it will.
Of course, you won’t know that it’s happening when it does.
In fact, you’re likely to develop a false sense of security about your ability to make financial decisions given that your confidence will rise over time.
To me, that’s the biggest danger.
Second, create a proper investment plan so that you don’t have to make complex decisions as you age.
Consider taking help from an expert financial advisor whom you trust (remember the advisor must be really trustworthy).
“But I’m still far from 45. This doesn’t concern me!”
I’m 33 and thus still have 12 years to reach the peak of my financial decision-making abilities. So shouldn’t I worry reading (or writing) all this?
Of course, I should!
This is because if I am young now, and know that my financial decision making skills are going to peak beyond 45 years of age, time is running out for me to make the right financial decisions.
So if I haven’t already started, I’ll start making them now!
Time isn’t money anymore. Instead, time ‘makes’ money.
See the chart below.
Assume you want to collect Rs 50 lakh by age 45 (when you know your financial acumen will start to decline), and you start now (whatever is your current age), the chart shows the required rate of return you need to earn every year to reach your target of Rs 50 lakh by 45.
As you can make out, the required rate of return rises geometrically with every year of delay you make in starting to invest.
For instance, if you are 25 now, you need to earn just 12% per year on your monthly investment of Rs 5,000 to reach Rs 50 lakh by age 45.
And if you are already 40, you need an annual return of almost 88% over the next 5 years!
So, till you have time in your hands, make full use of it to improve your financial decision making.
After all, it’s your financial freedom that is at stake.
However, if you are already above 45, don’t leave your financial decision-making to the 55-year-old version of yourself, who may not be as capable as the 35-year-old version.