As We Age, We Get Both Smarter and Less Smart

Public Affairs Forum

July 23, 2014

An interview with Eric Johnson, Norman Eig Professor of Business and Director, Center for Decision Sciences, Columbia University

Paula Tkac: Hi, I'm Paula Tkac with the Federal Reserve Bank of Atlanta's research department. I'm here today with Professor Eric Johnson from Columbia University. At our Public Affairs Forum tonight, Eric's going to talk about cognitive decision making and aging. Welcome, Eric.

Eric Johnson: Thank you.

Tkac: So, as the parent of a teenager, who often thinks he knows much more than the adults around him, what can you tell me about whether or not that belief is true?

Johnson: Well, there's good news and bad news. The good news is you know a lot more about the world than your teenager does.

Tkac: I knew that.

Johnson: But your teenager probably is faster at some things than you are. Give him the kinds of puzzles that people use to measure what's called fluid intelligence, and your teenager's probably a lot faster than you are at solving those.

Tkac: So, how do those two kinds of intelligence come together when we make decisions? When are you going to see one kind of intelligence really give you an advantage versus another, or can they compensate for one another?

Johnson: Well, it's a great question. What we find is actually, they compensate each other, because what happens is that fluid intelligence, the fast-thinking ability to rotate objects and figure out puzzles, does decrease with age, so that's the bad news. The good news is, crystallized intelligence—knowledge about the world, things like vocabulary, things like knowing facts—increases with age, at least to a point.

So, what happens is they actually compensate in lots of economic decisions, until somewhere in our 50s or 60s.

Tkac: So what kinds of economic decisions are we thinking about? I guess I'm thinking about financial decisions, but could it extend even to health care decisions and other kinds of decisions you might make?

Johnson: We've looked at deciding what kinds of repayment plans to have your credit card. So everyone knows you should pay off credit card with the highest interest first. Everyone doesn't include most people, however, and lots of people actually just like to get rid of a card, so we look at that as a task. We also look at people's FICO scores because that FICO score is great. And it turns out that people with better crystallized intelligence, particularly when it comes closer to financial literacy, are doing much better even when you hold constant things like income.

Tkac: And now we know some of those things like a credit score is going to be important for your ability to obtain credit. So if you're thinking about financing a child's education or retirement or house, this would seem to me to be a really important aspect of how you're going to be able to participate in the economy.

Johnson: In the paper, we use an example of somebody who basically gets one boost in crystallized intelligence and fluid intelligence. Crystallized intelligence has a three times as large boost [as fluid intelligence]. So we work through a numeric example that says that somebody who has ... what we call standard deviation, think of it as a 33 percent in the normal curve increase. And what that means is that they basically are saving hundreds of dollars a month on their interest. They have about a 1 percent advantage on the market for interest rate, holding constant again, income, age, and other things.

Tkac: So if I start thinking about this in differentials across, let's say now, the spectrum of folks out there participating in the economy and in financial markets, the young folks right out of college, those of us that are in our prime years, and those of us who are maybe thinking about quitting work and financing a wonderful retirement. How do I take these notions of intelligence and their effect on decision making and start thinking about how we might help folks make better decisions overall? So what do different kinds of people need?

Johnson: Younger people have a lot of processing capacity. You would give them five or six or 10 options, and they can blow through them very quickly. They can process the information. What they lack is knowledge of what financial institutions mean. For example, when we've done work on health insurance choice, lots of young people say deductible and they think it's something good. It's how much you can deduct from my costs. If you've been around the block and have had health insurance, you know deductible is not such a good thing.

So they lack in what we call crystallizing knowledge. So if you're going to help them you're going to need to supply that. But if you're thinking about older people, they know what deductible is. But if you, for example, in Massachusetts in the first health exchange, there were 47 different health insurance policies. I think the average person is just overwhelmed and can't possibly think about those 47. So you need to figure out a good way of reducing that in a way that gives them good choices.

Tkac: OK, and then what is the rule of public policy on this? So I mean, you have kind of outlined some. So if we're thinking of any role that the government might have in health care decisions and some other things, but is there a larger role for thinking about other forms of public policy that may not be directly empowering people's decisions but in the information they use to make their decisions?

Johnson: There have been lots of things that have happened in the last 30 years that have been radical shifts. The biggest one, of course, is change from defined benefit plans to defined contribution plans. That put a lot of decision making on each individual. Now that has an advantage, it lets people decide how to invest. What it made difficult is those people who didn't want to be that involved, they ended up doing things like not saving. So we've made some really important changes there that have made retirement savings much better. The really interesting question is, how do we do the same for what people call the deccumulation phase? That is, once I have my nest egg of whatever it is, let's say a couple hundred thousand dollars, how do I spend that down over time? And we don't have good solutions for that and I think financial services firms are going to have to do a lot of innovation to think about that. I think that we're going to have to have governments, both states—because some of these are insurance products—and federal governments think about how to encourage that innovation.

Tkac: Some prepackaged solutions, maybe?

Johnson: Something off the shelf.

Tkac: Like target day funds, other kinds of things that make that planning process simpler.

Johnson: Something that on “auto magic,” as we say, does the right thing.

Tkac: You talk about cognitive decline, at least in the fluid intelligence. Is there anything, it's a bit outside your own research, but are there thing that either can be done or are there sort of segments, professions, that tend to exercise your brain more? Or is this just something that is biologically predetermined in terms of the decline you're going to experience?

Johnson: It depends on your view of the brain. Some people think the brain is like a fixed capacity and you can't do anything with it. Other people think the brain is like a muscle, and if you exercise it gets stronger. And I think the evidence is sort of going that there is some sort of plasticity there that you can actually do more than we thought we could to help keep the brain healthy.

Tkac: Well, that's good news.

Johnson: I think so.

Tkac: Thank you, this has been a really interesting talk, Eric, and I look forward to your speech tonight.

Johnson: Thank you, thank you very much for having me.