8 Steps to Wealth Protection for Aging Investors

We've all received the pitch in the mail: Transfer your credit card balance to a new card at a lower interest rate. The catch: Payments on the new card will be applied first to the transferred balance; meanwhile, a higher interest rate is applied to new purchases--and payments are applied to that balance only after the transferred amount is paid off.

The solution is a no-brainer, right? Keep using your old card for new purchases until you've paid off the transferred balance on the new one. But research shows that cardholders of varying ages aren't equally proficient at figuring that out. One-third of cardholders will get it immediately--what researchers call the "eureka moment"--while another one-third never get it right.

Cardholders age 35-44 are most likely to have the eureka moment, because they're young enough to have acquired some financial smarts and still have most of their cognitive faculties intact.

Where is the greatest degree of confusion found? Among adults over age 65, according to the Center for Retirement Research at Boston College.

Documenting Decline
A growing body of evidence suggests that the aging brain isn't well-suited to financial decision-making. Roughly half of adults in their 80s suffer from dementia or cognitive decline that impacts financial management skills, according to David Laibson, an economics professor at Harvard University and co-author of a research report with three other economic and financial experts on aging and reasoning ability. Laibson laid out the worrisome findings at the recent Morningstar Investment Conference.

Other researchers have documented characteristics of poor decision-making in the elderly that leave them vulnerable to the marketing tactics of fraudulent and abusive financial services. A research team at the University of Iowa points toward problems with complex decision-making in some older adults who haven't been diagnosed with any specific neurological or psychiatric diseases.

"Many older people experience far more dramatic declines in cognitive abilities that are not related to memory, such as concentration, problem solving, and decision-making," according to Natalie Denburg, an assistant professor of neurology and neuroscience at the University of Iowa Carver College of Medicine.

Denburg's team found that impaired decision-makers were more vulnerable to deceptive advertising claims and tended to go for promises of short-term rewards at the expense of long-term benefits. "They also often assumed long-term benefits in situations where there are none," she adds. "We see these characteristics as direct consequences of neurological dysfunction in systems that are critical for bringing emotion-related signals to bear on decision-making."

Much is at stake; Laibson notes that $18.1 trillion of the $53.1 trillion in U.S. household net worth is held by the vulnerable population over age 65--a percentage that will rise as the baby boom generation ages in the years ahead.

"It turns out that our peak ability to make good choices in the world comes in the mid-50s, and after that there is a decline," Laibson says. "So we have to think about that, and of course dementia makes that decline even more severe."

A Sensitive--and Critical--Issue
The evidence on cognitive decline raises unpleasant, sensitive questions we all need to consider. Laibson says investors in their 50s and 60s should make plans for the possibility that "things will go badly" in their 80s. And if you're a younger adult with older parents, it may be time to have a frank conversation about how you can work together to protect them down the road.

Procrastination can be your worst enemy, because the timing of cognitive decline is impossible to predict--and once problems occur, you're no longer in a position to fix them yourself. That requires a proactive approach to issues that no one wants to contemplate.

"People who had been functioning well start to make poor investment and spending decisions," says Harry Margolis, an elder law attorney at Margolis & Bloom, LLP. "It's often very difficult to intervene. We see cases where the husband has been in control of finances and wants to keep doing so even if he can't do it very well."

Adult children can find getting involved just as difficult. Parents and children need to discuss and plan for issues that include everyday household finance, but also longer-range issues such as long-term care and estate planning. But these topics can be so charged with emotion that no one knows how to get the conversation started.

Just 47% of adult children say they have had detailed discussions with their parents about their income and expenses, according to the Employee Benefit Research Institute (EBRI) 2010 Health Confidence Survey. A slightly larger number (54%) of retired parents reported that they had those discussions.

But an even bigger gap emerged when EBRI asked adult children and retired parents if children were aware of the parents' approximate income. Just 42% of adult children reported they did know, while 63% of parents said they thought their children had the information.

 

Experts recommend that adult children look for a natural point of entry to start the conversation--for instance, raising an example of problems that have hit other family members or friends who failed to plan. And don't limit the conversation to money--make sure you have the contact information for key advisors, legal papers, and account documents.

Here are some key actions to consider that can help protect you or an aging parent from the financial pitfalls associated with cognitive decline:

Start with a financial checkup. "Many of my clients get a medical check-up before they retire, and we recommend a financial check-up as well," says Martha J. Schilling, an investment advisor in the Philadelphia area. "We work on simplifying their accounts, reviewing the estate-related legal documents and ensuring that spouses have a good understanding of assets and that they communicate with each other how they would like assets distributed at their demise or incapacity."

Put assets on cruise control. Our ability to make sound investment decisions declines with age; Laibson says research points toward a 300-basis-point disadvantage in risk-adjusted returns for older investors due to bad decision-making, especially in the areas of fees and diversification. So, consider taking steps in advance to reduce the need for active management of your assets. Active investors should consider becoming passive investors past their 60s by placing assets in low-cost index funds; also consider "automatic" products such as single premium income annuities that pay regular monthly income via electronic deposit.

Protect against fraud. Elderly people with decision-making impairment need more than support from family and friends. They need legal and societal protection from fraud and predatory marketing.

"Unfortunately, we cannot always rely on the patient to report his own problems," says Denburg. "People with frontal lobe dysfunction often suffer from impaired awareness and insight, and they aren't aware of both their own deficits and the ways in which their behavior affects other people. They will deny that they have anything wrong with them, even though their deficits are patently obvious to everyone around them."

Denburg recommends that family and friends be on the lookout for disturbing external signs, including accumulation of large amounts of mailers with disguised sales pitches, frequent phone and mail-order purchases, large bank withdrawals and dwindling savings. "Some older adults and their families have set up safety mechanisms such as putting limits on bank withdrawals, and personal checks," she says.

And steer clear of any sort of private investment that isn't available on the public market. "I can't tell you how often I've heard of someone whose friend recommended a no-miss investment in land or a timeshare that turns out to be a scam," says Cindy Hounsell, director of the Women's Institute for a Secure Retirement.

Find a fiduciary. Don't work with a financial advisor who is not a fiduciary--a legal definition that requires an advisor to put the best interest of a client ahead of all else. Regulation of financial advisors is changing, as Washington debates how to pull brokers under the fiduciary umbrella. The outcome of that discussion isn't clear, but for now, only Registered Investment Advisors are fiduciaries. And hire an experienced, but younger advisor to get the best odds that she'll still be in business when you need help the most.

Make a succession plan. Pick someone you trust to manage your affairs in the event that you're unable to do so. "Family members are usually at the top of this list, and then friends," says Deborah Jacobs, a lawyer, business journalist, and author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide. "For some people it can be a younger friend, maybe someone you know through church. That sometimes makes the kids suspicious but it doesn't have to be bad."

Margolis sometimes recommends bringing in a bank or trust company as professional trustee at the same time that he establishes revocable trusts for clients.

Many attorneys point to the living, or revocable trust as the preferred vehicle for giving your trusted co-pilot the legal power to act on your behalf if necessary. The process involves retitling your key accounts and assets to the trust.

"They're well accepted by financial institutions, and you don't have to give up control," says Margolis. "You're naming a co-trustee who can step in if necessary. And your trustee can keep an eye on what's going on--if you make a crazy investment or suddenly start spending a lot of money on the Home Shopping Network, the trustee can take action."

The living trust also serves as the controlling document for disposition of most of your estate after your death. These are most appropriate for individuals with substantial assets and complex holdings; sometimes, durable power of attorney documents can suffice, Jacobs says.

Consolidate. The process of establishing a living trust has another benefit, in that it kicks off an inventory of your accounts and assets; that presents an opportunity to consolidate. "We often see clients who have accumulated retirement accounts at various jobs, and other assets," Margolis says. "It can be very difficult to know what they actually have."

Plan long-term care. Include in your plan the possible cost of incapacitation that requires nursing care. One-third of Americans will need long-term care at some point in their lives, according to the Center for Retirement Research at Boston College, with semi-private nursing room costs hitting $77,000 per year.

It's possible to self-insure if you can set aside $500,000 to $750,000 in assets that could be tapped for LTC without wrecking your overall retirement plan. If not, consider buying a long-term care insurance policy. A 55-year-old couple could buy a policy with three years of coverage, a $150 daily benefit, and 5% inflation protection for about $1,500 per year, according to the American Association for Long-Term Care Insurance.

Most important: don't procrastinate. "It's hugely important," says Jacobs. "You could reach a point where balancing a checkbook or managing a certain amount of money becomes overwhelming--but you're not incapacitated in the legal sense. It's a matter of degree and hard to admit you've reached that point or that you need to ask for help."

And, she adds: "We're heading into a world where there will be a lot of people who haven't done what's necessary."

Mark Miller is a retirement expert and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.