Older adults with higher cognitive ability more likely to take on debt

It sounds strange, but could increased financial literacy lead to financial fragility?

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Older adults hold more debt today than in past generations, and a new study from the University of Michigan shows a correlation between indebtedness and cognitive ability. This relationship is even more pronounced during the pandemic. Much of the increase in total debt is due to older adults with higher cognitive ability taking on disproportionately more mortgage debt in response to increasing local home prices than their counterparts with lower cognitive ability. In addition, adults with higher cognitive ability also take on greater debt of other types, such as credit card and medical debt.

“We find that cognitive ability is an important predictor of debt burdens in older age and that this relationship has changed over time during the period of expansion in financial complexity,” according to researchers from the University of Michigan. “Our results suggest that older adults with higher cognitive ability have taken on more debt relative to their counterparts in more complex financial environments.”

There has been some concern that greater financial complexity would disproportionately increase relatively unsophisticated consumers’ indebtedness because of poor choice of debt instruments.

However, results suggest that individuals with higher cognitive ability, and particularly higher financial literacy, are more likely to take on higher debt burdens in more complicated financial environments.

This is consistent with research documenting that risky and complex financial instruments are more likely to be adopted by relatively financially sophisticated individuals.

“All told, we find that individuals with higher cognitive ability disproportionately increased their debt burdens during the increase in financial product complexity and that subsequently, they were more financially fragile than similar individuals in previous cohorts,” researchers said.

Current and future retirees’ financial security may be more in jeopardy across the financial sophistication spectrum, and older adults may be less financially resilient to financial shocks than past cohorts.

“An area of important future research is to examine how the COVID-19 crisis has affected older adults’ retirement security and debt exposure,” the study concluded. “Our results suggest negative impacts may not be solely, or even primarily, confined to those who are less financially sophisticated.”

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