Does Loss Aversion Grow Weaker With Age?
by Christian Gressner, ProjectM Online
As people get older, they focus more on what brings them joy, according to Project M. That could mean older retirees are more likely to ignore negative events such as financial losses—which could have big implications for plan sponsors and advisors.
The author of a prominent theory in modern-day psychology, Laura Carstensen is unimpressed with her own achievements. "A theory is just a theory until it has been tested. True insights only emerge where it has been falsified and we know what is right or wrong."
Applying such scrutiny to her findings, Carstensen's research inched forward over roughly a decade until it became known as the socioemotional selectivity theory, which stipulates how time affects our goals and motivations. "From our early work we know that goals are changing systematically with age. We are now examining how this affects our memory and the way we direct our attention," Carstensen, the professor of psychology and director of the Stanford Center on Longevity, told Project M.
Yet it is not time lapsed that changes our preferences, but time remaining. "The subjective sense of remaining time has profound effects on basic human processes, including motivation, cognition and emotion," Carstensen wrote in a 2006 Science article. "Socioemotional selectivity theory maintains that constraints on time horizons shift motivational priorities in such a way that the regulation of emotional states becomes more important than other types of goals." In more mundane words: With fewer years remaining, older people focus more on what they enjoy, namely meaningful relationships with close friends and family members.
This questions the concept of chronological age. A good predictor of cognitive abilities, language and motor coordination among the young, it becomes an increasingly poor predictor at older ages, according to Carstensen. Theoretical models of human development that focus almost exclusively on the passage of time since birth need to be overhauled—with a direct impact on the premises of financial planning, particularly when it comes to retirement savings and life-cycle products.
"When time horizons are nebulous and seemingly unending, as they are in early adulthood, our goals are about preparation, exploration and learning," Carstensen said. This makes sense: With the larger part of life ahead and little sense of direction, one is best-advised to think broadly and prepare for what is even remotely likely. Yet with much of our life lived, we are free to return to what is dear to our hearts: "Older people focus more on goals that are emotionally meaningful," said Carstensen.
Yet we hardly rely on facts and figures when developing motivations and setting goals. Cognitive processes are based on a subjective sense of time, which can be manipulated. Experiments have shown that when told they will soon move to a distant part of the country, younger people prefer to meet close friends and family members rather than a remote acquaintance who seems to have much in common with them. Their reaction resembles that of older adults. Similarly, Carstensen found that events such as the 9/11 terrorist attacks and the severe acute respiratory syndrome epidemic in Hong Kong in 2003 completely eliminated age differences on some measures of motivation.
What this means for loss aversion
Carstensen's findings take the notion of loss aversion to a new level. Stating that people are more sensitive to loss than to gain is considered a truism for all humans. Yet relevant studies were almost exclusively conducted with younger participants, and Carstensen challenges the linear understanding of loss aversion. "We suspect the concept of loss aversion may not be true for older adults," she said. If older people are joy seekers and this preference directs their attention, they are likely to ignore negative events such as financial losses, in what Carstensen calls the "positivity effect." She infers that loss aversion must then decrease with age. And tomographic imaging proves her right. "Brain activity, when anticipating a potential loss, is significantly lower among older people than among younger." Neural activity is similar in both age groups when anticipating a potential gain, Carstensen and her co-authors wrote in Nature Neuroscience.
This has far-reaching implications for everything related to finance and old age, ranging from financial literacy to elder financial abuse. It has also led the Stanford Center on Longevity to cooperate with regulators, such as the Financial Industry Regulatory Authority, as well as with service providers. While the positivity focus is a default mindset among older people, it too can be manipulated. And maybe it should be, when it comes to financial education and advice for older workers and retirees. "Even telling people about these findings is helpful in eliminating them," said Carstensen.
While the gift of longer lives that humanity has received over recent decades naturally affects us, Carstensen also suggests that the approaches to both saving for and spending in retirement need to change. "We have not focused much on decumulation," she said. "With shorter lives it wasn't quite as urgent."
She advocates working longer or going back to some form of training at later stages in life. Workers may also consider taking sabbaticals to spend time away from work to look after young children. "We have to get away from the notion that we have a few extra years tacked on at the end," explains Carstensen. "That is a crisis of creativity, not a crisis of aging."
This article was originally published in Project M, an Allianz SE International Pensions publication featuring unique perspectives on investments and retirement.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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