Research Shows that Self-efficacy Leads Seniors to More Positive Financial Outcomes
As individuals age, they need to make financial decisions about asset management both before and after retirement. However, as a person ages, their cognitive* abilities may also decline and impact their ability to make financially sound decisions.
Ning Tang, finance professor at the Fowler College of Business at San Diego State University sets out to investigate the impact on cognitive abilities on the financial behavior of older adults. Her resulting research findings, currently accepted for publication in the Journal of Economic Psychology, examine the two channels through which cognitive capabilities influence the behaviors of older adults. Specifically, Tang looked at the attributes of ability and self-efficacy (defined here as an individual’s belief in their ability to control and influence various aspects of life) and their impact on financial decision making.
This is important says Tang because: “Cognition* not only determines the ability required for optimal financial decision making, but also exerts a positive effect on self-efficacy, which significantly affects financial behavior as well. That is, when the older population experiences cognitive aging, they suffer not only from a weakening cognitive capacity but also from a decline in self-belief in their ability to control and manage various aspects of life, which, in turn, leads to lower financial management efficiency.”
Tang tested three hypotheses regarding the impact of cognitive ability and self-efficacy on financial decision-making. Her first assertion is that “after controlling for other determinant factors, higher cognitive abilities predict more efficient financial behavior.” In other words, the greater the individual’s information processing and problem-solving ability, the more likely the individual will exhibit sound financial behavior.
Ning Tang, Ph.D., Associate Professor, Finance Department
Secondly, Tang asserts that the effect of cognitive abilities on financial behavior is stronger in decisions demanding more information processing and analytical ability. If cognitive abilities influence financial behavior through the ability channel, she suspected that financial tasks such as financial wealth accumulation and investment should have a stronger link with cognitive abilities than routine tasks (making ends meet, for example).
Tang’s third and last hypothesis assumes that higher cognitive abilities result in more self-efficacy, which leads to more efficient financial behavior, after controlling for other determinant factors. This means that cognitive aging could negatively affect older adults’ life to a larger extent than merely causing performance loss in tasks that require cognitive capability. Thus, non-cognitive skills such as self-efficacy could be the other source of intervention to combat the negative impacts of cognitive aging.
To test these assertions, Tang used data gathered by the U.S. Health and Retirement study (HRS) which was sponsored by the National Institute on Aging and the Social Security Administration. The data obtained from HRS provides information on respondents’ financial behavior, income, wealth, employment, and demographic characteristics. It also contains information on the respondents’ cognition and self-efficacy levels.
Tang selected data gathered from multiple modules that measured income, wealth, financial behavior and outcomes, cognition test scores, self-efficacy test scores, demographic information, and other relevant information on individuals aged 51 - 104. She also created six indicators of financial behavior ranging from routine tasks such as timeliness of mortgage payments to advanced tasks like whether the growth rate of financial wealth exceeded the median growth rate of the peer group. To assure an unbiased outcome, Tang used controls such as education, income, wealth, and risk preference along with other variables that may confound the effects of cognitive abilities.
Tang explored the cognition measurements based on memory, vocabulary and numeracy tests to determine the subjects’ ability to process and analyze information. After analyzing the data which measures cognitive abilities against data measuring issues like household wealth, risk preference, home ownership and other attributes that impact financial behavior, Tang determined that higher cognitive abilities had “a significantly positive effect on financial behavior” which is consistent with her first hypothesis.
Tang then divided financial behavior into “routine” and “advanced” tasks, she found that the positive effect of cognitive abilities is stronger among advanced tasks, thus consistent with her second hypothesis.
In the final phase of her research, Tang first confirmed the positive impact of cognitive abilities on self-efficacy. Then she found evidence that higher self-efficacy scores also predicted improved financial behavior. This information confirmed Tang’s third hypothesis.
In conclusion, Tang noted that declining cognitive abilities in older individuals may have a serious impact on their ability to make sound financial decisions, especially for advanced tasks. “Older people may suffer from worse financial outcomes, not only due to deteriorating cognitive abilities, but also because they lose belief in their abilities and stop making an effort to manage their finances,” she said. “Since cognition has a positive correlation with self-efficacy, efforts need to be made by policy makers and financial advisors to enhance older adults’ beliefs in the abilities which can motivate them to improve their financial situation.”
*Cognition: the action or process of acquiring knowledge and understanding through thought, experience, and the senses.
The research is supported by the TIAA Institute research grant.
