Aging, Financial Literacy, and Fraud

November 27, 2012

Aging, Financial Literacy, and Fraud
Source: Social Science Research Network

We use a unique dataset to examine the financial literacy of older Americans and its importance for their financial decision making. The aging of the population and the shift to individual retirement accounts make this topic of growing importance to individual and societal well-being. First, we test how cognitive changes associated with aging impact financial literacy. We find that a decrease in cognition is associated with a decrease in financial literacy. A decrease in cognition also predicts a drop in self-confidence in general, but importantly, it does not predict a decrease in confidence in managing one’s own finances or in one’s financial knowledge. In fact, a decrease in cognition predicts increased overconfidence about one’s financial knowledge. Second, we test the hypothesis that overconfidence is a significant risk factor for being victimized by financial fraud. Financial fraud is a major threat to older Americans that is growing rapidly. We find that overconfidence in one’s financial knowledge is a significant predictor. A one standard deviation increase in overconfidence increases the odds of falling victim to fraud by 38%. The overconfidence of fraud victims is further demonstrated by their increased propensity to hold a concentrated investment. Our results suggest that increasing the financial awareness of older Americans is likely to help protect them against becoming victims of financial fraud.

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