BPEA | Fall 2009

The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation

David Laibson, Sumit Agarwal,
Sumit Agarwal Federal Reserve Bank of Chicago
Xavier Gabaix, and
Xavier Gabaix New York University
John C. Driscoll
John C. Driscoll Board of Governors of the Federal Reserve System

Fall 2009

Many consumers make poor financial choices, and older adults
are particularly vulnerable to such errors. About half of the population between
ages 80 and 89 have a medical diagnosis of substantial cognitive impairment. We
study life-cycle patterns in financial mistakes using a proprietary database with
information on 10 types of credit transactions. Financial mistakes include suboptimal
use of credit card balance transfer offers and excess interest rate and fee
payments. In a cross section of prime borrowers, middle-aged adults made fewer
financial mistakes than either younger or older adults. We conclude that financial
mistakes follow a U-shaped pattern, with the cost-minimizing performance
occurring around age 53. We analyze nine regulatory strategies that may help
individuals avoid financial mistakes. We discuss laissez-faire, disclosure, nudges,
financial “driver’s licenses,” advance directives, fiduciaries, asset safe harbors,
and ex post and ex ante regulatory oversight. Finally, we pose seven questions
for future research on cognitive limitations and associated policy responses.

This paper was the winner of the
2010 TIAA-CREF Paul A. Samuelson Certificate of Excellence
 for outstanding research containing ideas that the public and private sectors can use to maintain and improve America’s lifelong financial well being.