Does Investment Skill Deteriorate With Age?∗

This study focuses on the stock investment choices of older investors. Consistent with the theoretical predictions of life-cycle and learning models, we find that older investors hold less risky and better diversified stock portfolios, and their choices reflect greater knowledge about investing. However, consistent with the psychological evidence on cognitive aging, we also find that older investors have worse stock selection ability and poor diversification skill. The adverse effects of aging are stronger among older investors who are also relatively less educated, earn lower income, and belong to a minority ethnic group. The economic costs of aging are significant – older investors earn roughly 2% lower annual returns on a risk-adjusted basis. Collectively, our results indicate that while older investors’ portfolio choices reflect greater knowledge about investing, investment skill deteriorates with age due to declining cognitive abilities. THE OLDER POPULATION IN THE UNITED STATES is growing at a dramatic pace and it is also becoming more diverse in terms of its racial and ethnic composition. Because of the dramatic growth in the proportion of older people, there has been heightened interest in understanding their post-retirement quality of life. Particularly, there have been concerns that older people might not be able to generate the annual income necessary to sustain the pre-retirement quality of life. As the U.S. population ages, it becomes particularly important to understand the portfolio choices of older individual investors because investment income is likely to be a significant proportion of their post-retirement income and hence an important determinant of their post-retirement quality of life. According to the 2004 Federal Interagency Forum on Aging-Related Statistics, in the year 2000, older people (people aged 65 and above) represented about 12% of the population and by the year 2030, their proportion is expected to increase to about 20%. While the proportion of older people is expected to rise across all racial and ethnic groups, the growth rates are significantly higher (about 60% for Hispanics and 20% for African Americans, compared to only 8% for Whites) among the minority groups. In the year 2000, the older population was predominantly (about 84%) White and African Americans and Hispanics represented only 8% and 6% of the population. In contrast, in the year 2030, the Whites, African Americans, and Hispanics are expected to represent 61%, 12%, and 18% of the U.S. population, respectively. Reynolds (2005) raises several thought provoking questions about the ability of older people to retire successfully. Our study has been partially inspired by the questions raised in that article, which is available online at http://www.nd.edu/∼ndbizmag/spring2005/Feature Old web.shtml.