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The biggest retirement risk no one talks about
You won't see it in television ads about retirement. You won't hear it at investment conferences. You probably won't read much about it in newspapers or personal finance magazines or on the Internet.
And yet the biggest threat we face to our financial security in retirement may be the massive drop-off in our own capacity to manage our investments as we age.
Physiological changes in the aging brain can cause significant declines in our ability to process new information, handle risk or react appropriately to market events.
They make older people more vulnerable to scam artists, of course, but they also make it much harder for the elderly to make good investment decisions.
And it's not just about dementia, whose likelihood doubles every five years as we age. A large percentage of people who live into their 80s — and there are more and more of them all the time — will suffer some form of cognitive impairment.
I know this is something most of us don't want to think about. But there are steps you can take earlier — probably in your 60s — to protect yourself, your wealth and your family.
The roadmap of decline in investing ability is rooted deep in human biology, and here I need to make a brief and, I hope, painless foray into the physiology of the human brain.
"A lot of the cognitive functions or processes involved in financial decision making are located in the frontal cortex," said Dr. Joe Verghese, a professor of neurology at Albert Einstein College of Medicine and chief of geriatrics at Einstein and Montefiore Medical Center in New York.
Because of the cortex's predominance throughout much of adulthood, we get better and better at investing until we hit our mid-50s, when we begin a slow, inexorable decline.
Why? As we age, the limbic system, one of the oldest structures in the human brain and the seat of primal emotions like fear and greed, becomes more and more powerful.
"As we get older, our prefrontal cortex has a more difficult time tamping down emotions, and it may have more difficulty putting complex information into context," Michael S. Finke of Texas Tech University told me.
Around 70, wrote Alok Kumar of the University of Miami, investment skill "deteriorates sharply" and investors' "ability to handle risk declines."
That can lead to panic selling, such as the kind we saw in 2008-2009. With hindsight, buy and hold was the way to go. But try telling that to a 75-year-old widow who watched a third of her retirement savings go up in smoke.
"Investors who are carrying market risk by holding a large amount of stock may be more susceptible to cognitive-driven underperformance," Finke told me in an interview.
How widespread is this?
David Laibson, who specializes in behavioral finance at Harvard University, said in a 2011 interview with the American Association of Individual Investors that between those who have full-blown dementia and other kinds of cognitive impairment, "we're talking about, in total, half the 80-year-old population that is not in a position to make important financial decisions" (italics added).
That means you and me, my friends.
This is what the financial-services industry, obsessed with preventing retirees from outliving their money, just doesn't get: What good are sophisticated solutions like inverse glide paths if half your clients have trouble balancing their checkbooks?
Albert Einstein College of Medicine's Verghese sees these problems all the time. "At my clinic, I see patients brought to me because they're making bad decisions or losing money," he told me. They are typically in their 70s, he said.
We all have our own stories. I had a beloved aunt who was sharp and funny her whole life but became noticeably forgetful after she turned 80. On a visit, I found months of unpaid condominium maintenance bills piled up in her desk drawer. Had we gotten there a month later, her condo might have been sold on the courthouse steps.
That's why, as we age, we need to look for regular income through some kind of annuity besides Social Security; automatic solutions like regular rebalancing or life-cycle income funds; and a support network of friends and family to lean on with specific instructions for spouses and survivors.
Things we should avoid: focusing on individual stocks or putting too much into equities or exotic "alternative" investments with brief track records and unexpected volatility. And active trading, which is a joke for most people anyway, could be a catastrophe for older investors.
"Based on our evidence, a passive buy-and-hold strategy seems most appropriate for older investors, especially if they hold larger portfolios," the University of Miami's Kumar told me in an email.
So, "keep it simple" should be the mantra, especially as we age. "You've got to address these issues at 60 instead of 80, because at 80 you may be too late to the game," Harvard's Laibson said.
"I think you should do it as early as possible," agreed Verghese, adding: "If you haven't done it at age 70, that's not too late."
There are all kinds of risks in investing: economic crises, political turmoil, market panic, whimsical central bank policy. Handling them is tough enough. But who knew that the biggest risk of all may be our own aging brains?
This article originally appeared on MarketWatch.com
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