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Are You Smarter Than a High School Dropout?

It’s no secret our mental sharpness dulls a bit with age. A new study from Texas Tech University suggests that even accredited investors in their 80s are likely to be less financially savvy than a high school dropout.

Age Eliminates the Advantage of Experience

The cognitive decline associated with their age apparently wiped out any advantage these high net-worth individuals may have once had when assessing potential investments. They fared badly when their financial smarts were compared with counterparts in all age groups.

Accredited investors, who have more money to invest, are able to buy risky, unregistered securities such as private equity, venture capital and hedge funds with little regulatory oversight. Regulators long ago concluded this is justified, assuming investors who meet the accredited investor thresholds ($200,000 annual income or $300,000 for a couple, or a net worth of over $1 million, excluding primary residence) are sophisticated enough to understand these complex and opaque securities.

The philosophy is based on a desire to protect smaller investors, who would be badly hurt if they took a big hit from an investment gone wrong.

The Age-Old Counterpoint

Not so fast, say advocates of revising the regulations, who want to open up these riskier investments to more people. They argue the rules see “sophistication” as a measure of a person’s bank account, not a person’s brains.

Researchers used financial literacy assessments from two surveys to reach their conclusions. The Consumer Finance Monthly (CFM) and the Health and Retirement Study (HRS). They wanted to know whether older accredited households, who have accumulated significant savings, are smarter when it comes to assessing potential investments than younger unaccredited respondents.

In both data sets, they found that accredited households age 80 and older are more than 80% less likely than unaccredited investors age 60-64 to have high financial literacy scores. In fact, respondents with less than a high school degree were more likely to have a high financial literacy score than older accredited respondents, according to this analysis.

While accredited investors are more financially literate than unaccredited investors within each age group, older accredited investors had significantly and sharply lower financial literacy scores than younger, unaccredited investors – and the difference increased consistently with age.

The researchers asked questions such as:

  • “If your assets increase by $5,000 and your liabilities decrease by $3,000, your net worth would… (1) Increase by $2,000 (2) Increase by $8,000 (3) Increase by $3,000” and
  •  “The benefit of owning investments that are diversified is that it … (1) Reduces risk (2) Increases return (3) Reduces tax liability.”

This may not be too surprising, but it is of interest, especially since there is debate surrounding whether the accredited investor definition should change.

What to Expect Ahead

Accredited investors account for 8% of the U.S. population but hold 70% of the country’s total household wealth. The authors of the study suggest regulators should look at more than household wealth when defining who should be able to put money into risky investments, such as early stage companies.

“We find strong evidence that these older households are at greatest risk of meeting the accredited investor definition without having the sophistication needed to avoid high agency costs in a largely unregulated securities market,” they write.

The researchers measured financial sophistication as the percentage of correct responses to 16 financial literacy questions.

The percentage of financial literacy questions correctly answered among accredited investors age 80 and over was about half (45.7%) the score at age 60-64 (78.4%).

Accredited investors above age 80 had lower financial literacy scores than every group of non-accredited investors younger than age 75, according to these results. The same patterns showed up in both surveys.

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