Money Pitfalls and Cognitive Decline: How to Recognize the Signs

If you're a retired or soon-to-be retired investor, you've probably gotten the calls and invitations to "free" lunches and dinners. You know the pitches: Higher yield with little risk.

Most of us know something is not quite right about this relentless hawking. Most, if not all, of these offers are too good to be true, and we avoid them--unless we truly just want that free meal and can walk away without buying something.

But sometimes number gremlins creep up in insidious ways on older Americans: They invest in a highly risky security or sign up for an annuity they didn't need. I've known family members and parents of friends who've gotten ensnared in these financial faux pas, although they are acutely embarrassed to talk about them.

It's long been known that the ability to deal with numbers declines with age. But until recently, few knew exactly what that meant, other than older investors increasingly become targets for financial scams.

Although our ability to make sound financial decisions gradually erodes with age--starting at around age 20--there's a pronounced fall-off in the ability to sort through numbers, also known as "fluid intelligence," starting at age 53 according to a Brookings Institution study.

Yet those with diminished mental acuity may not know it and can get into trouble. That's why it's incumbent upon family members and health and financial professionals to keep an eye on those who may not realize they are making bad judgments with money.

Cognitive impairment can be challenging for families trying to guard against financial abuse. Many older Americans, though not experiencing outright fraud, may be subject to financial mistakes such as borrowing excessively or buying ultra-risky investments, notes a Brookings Institution study.

Since many complex investments--including variable annuities, unlisted real estate investment trusts, and structured products--contain a great deal of dense financial jargon, the fine points of their risk profile and embedded costs may be opaque to older adults--and often even to younger investors.

Then there's the social element: Older investors may be alone and isolated from family and social networks, and may fall prey to people they think they can trust without being able to objectively analyze the risk of certain vehicles. They also may be hampered by a dependency on third parties for care, or by depression, bereavement, or financial responsibility for an adult child or spouse. That's why family vigilance is essential.

The Other Side of the Coin
Fortunately, the news is not all bad concerning cognitive decline. "Crystallized intelligence," which is built on experience, can remain solid well into old age.

So if you or a family member has had a bad experience with a financial professional, you may recall it and take precautions. "Once bitten, twice shy," the old maxim goes.

Moreover, the widely reported prevalence of fraud among older investors may be overstated as well. Three researchers from the University of Waterloo in Canada have challenged the notion that there's a higher degree of fraud among older persons. Although more research is needed because senior financial abuse is notoriously under-reported, the researchers noted:

"We review evidence on the prevalence of consumer fraud and conclude that there is no clear indication that it is more prevalent among older persons. Aggregating across all consumer frauds, there is evidence that consumer fraud is less common among older persons than adults of other ages."

Nevertheless, it pays to be vigilant. Here's what every family should carefully consider and execute:

• Are there signs of financial distress? Is a family member behind on bills or for some reason unaware of them? Did he or she forget about paying some bills?
• Are they having problems with mental math? Are they having difficulty doing simple arithmetic such as figuring a restaurant tip or balancing a checkbook? Do they run out of money at the end of the month?
• Are they experiencing a loss of conceptual knowledge? For example, have they lost the ability to know how a line of credit or reverse mortgage works, and how much they might owe?
• Are they having problems with activities of daily living such as bathing, cooking, cleaning, or self care? Are they exhibiting any changes in appearance or poor hygiene?
• Has a stranger or someone working for them offered to help them with their finances? Have they been approached by anyone (other than family members) requesting power of attorney, a change in a will, or access to a bank account? Do they have a "new friend" who has promised to manage their money or enrich them?
• Are they experiencing a loss of judgment on investments? Do they understand how much risk is involved in different vehicles? Are they taking on extraordinary risk for their age and financial sophistication?
• Do they have safeguards in place for cognitive incapacity? Common documents include a living will, durable power of attorney for health care and finances, and health-care proxies. All of these directives appoint someone to make decisions if they lose the ability to do so.

In most cases, an estate-planning attorney can draft all of the necessary documents to transfer decision making to a responsible family member or professional.

In the event that you suspect or detect financial abuses, report it to the local authorities.

A key resource is the North American Securities Administrators Association, a group representing state and provincial securities watchdogs. Not only can you track down your local securities agency, you can find out whether brokers are registered or had complaints lodged against them.

John F. Wasik is a freelance columnist for Morningstar.com. The views expressed in this article do not necessarily reflect the views of Morningstar.com.