Some studies suggest that the mid-50s is when the quality of financial decisions reaches its peak. Unfortunately, this zenith of our economic power seems to occur both before and after it is needed most.
There is a U-shaped pattern in our lives in terms of the number of poor choices we make. Because we don’t have much experience managing money, we make more mistakes early on, such as not paying our bills on time or paying more interest on our loans than we should.
But over time, we learn from our previous choices and become more financially confident as we make more decisions. Our error rate decreases until our mid-50s, but then increases as our brains begin to fail.
The impact of the large and frequent mistakes we make early in life is even greater because they occur at a time when we are building the financial foundation for our future. The cost of waiting to start a long-term savings habit is especially painful in hindsight when you consider the consequences of not starting 10 or 20 years earlier. The most harmful mistake is missing out on the benefits of compound interest.
A good example of the power of compound interest is to look at pairs of twins. One started investing at age 18, and the other delayed investing for 10 years until she was 28. Calculating the rate of return and assuming monthly contributions of $100, a person who started contributing at age 18 will still earn more than his brother, who stopped contributing at age 28, than his brother who waited until age 28 and continued contributing for the next 37 years. Ultimately he could earn more money at age 65.
These types of examples use a number of simplifying assumptions, such as that consistent annual returns can be earned and that late-onset twins do not increase their contribution over time. But when it comes to motivating savings, the simpler the better. And they are motivating if you are young, but demotivating if you are not.
The cost of mismanaging your cash flow and racking up double-digit interest on your credit cards is not only temporarily painful, but it’s also notoriously difficult to get out of. Some people may unknowingly fall into a perpetual cycle of moderately stable credit card balances, but those who have reached a financial breaking point may be more motivated to turn it around. not. Either way, spending too early on is a bit too reckless and will snowball into another delayed start to your future financial freedom.
Having benefited from the experience and knowledge gained, we may now, at age 53, look back with some regret and wonder what might have been had we taken action sooner. It’s especially heartbreaking when you start to realize that retirement may be around the corner.
In the 20 years to 2019, the proportion of private pension plan participants in gold standard defined benefit plans fell from 85% to 39%. (The decline in the public sector was from 98% to 91%.)
Responsibility for retirement security has gradually shifted to individuals. Combine this with declining cognitive function and longer lifespans, which increase financial errors from the mid-50s onwards, and the weight of these realities becomes clear. The stakes are even higher.
For young people, the lesson is simple. Get started now. Time and the power of compound interest are on your side. For older generations, it is very important to be aware of the challenges associated with aging. Open communication with family members and trusted advisors can help you navigate complex financial decisions as your cognitive abilities evolve.
Denying the inevitable does not serve us. Instead, it’s important to accept it and plan accordingly. Proactivity and collaboration are our best allies in a changing financial landscape.
Preet Banerjee I am a consultant to the wealth management industry with a focus on commercial applications of behavioral finance research.
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