Sholmo Benartzi is a professor and co-head of the behavioral decision making group at UCLA Anderson School of Management and author of “The Smarter Screen” about online behavior. Alan Castel is an associate professor of psychology at UCLA. This op-ed appeared recently in the Wall Street Journal.
How well do you remember the last financial crisis? Can you clearly recall what happened to your finances?
Most people are pretty confident in the accuracy of their memories. Unfortunately, decades of research suggest their confidence is likely misplaced. And that overconfidence can cost them, especially as they age.
The human brain isn’t like a computer hard drive; rather, it is full of quirks and blind spots, which can make it difficult for investors to remember exactly how much the S&P 500 lost between 2007 and 2009. (Answer: the S&P lost more than 50 percent of its value.) These blind spots can have serious consequences, leading people to take far more risk than they can actually afford.
New research suggests that the distortions and gaps in our memory change as we get older. While most people assume that our memory simply gets worse over time, the reality is more subtle and complicated. Older adults have more experience, and perhaps the benefit of perspective, but they also have to deal with specific biases that influence the details of what they remember.
Bias for good news
Consider a study led by one of us (Dr. Castel), which showed subjects a series of faces paired with a specific monetary gain or loss. For instance, a brunette’s face might appear with a loss of $100, while a man with a goatee might come with a gain of $50. As expected, both young and old subjects were more likely to remember the pairings when they were associated with bigger monetary amounts.
However, interesting age-related differences emerged when the scientists looked at how well young and old people remembered gains and losses. While the young undergraduates were most likely to remember big losses, the older cohort — the group had an average age of 78 — did relatively better when shown faces paired with large gains. When it came to the largest losses, the senior citizens were approximately 25 percent less likely to recall the face-pairing than the young adults.
This finding builds on previous research showing that older adults pay more attention to positive information, like gains, suggesting a bias for good news built into the aging process. In addition, older adults also showed a recency effect, as they did relatively better when asked to recall money-face pairings they had just seen.
Taken together, this new research raises some important questions about how our memory might impact financial decision making as we get older.
While more research is needed in this area, the current evidence suggests that older adults might have unique blind spots related to risk, especially if the market has been on an upswing in recent years. Because older adults show a bias toward gains and tend to remember the latest events, a bull market might lead them to forget about the last bear. Such forgetting can lead to serious decision-making mistakes. Unless we remember the lessons of the last crisis — what it felt like to watch as our portfolio was slashed in half — then we are bound to take excessive risk.
One way to deal with these potential pitfalls is to rely on financial autopilots. If you’re still accumulating assets, then target-date funds could work well, as those funds automatically adjust portfolio allocations as investors get older. If you are already drawing down assets to pay for living expenses, then annuities provide an autopilot solution for your paycheck. (Purchasing an annuity is often an irreversible decision, however, so getting help is a good idea.)
Such financial autopilots help counteract the positivity bias of old age, in which we pay less attention to our losses. It’s good to remember the good times, but forgetting about the bad can cost us money.