The Age of Reason:
Financial Decisions Over the Lifecycle
Sumit Agarwal
John Driscoll
Xavier Gabaix
David Laibson
Federal Reserve Bank of Chicago
Federal Reserve Board
NYU and NBER
Harvard and NBER
May 2008
The views expressed in this paper are not necessarily those of the Federal Reserve Bank
of Chicago or of the Federal Reserve Board.
“Performance” peaks.
• Baseball: 29 (James 2003)
• Mathematicians, theoretical physicists, and lyric poets:
early 30s (Simonton 1988).
• Chess players: mid-30s (Charness and Bosman 1990).
• Autocratic rulers: early 40s (Simonton 1988).
• Novelists: 50 (Simonton 1988).
• Economists?
– 20s (Hamermesh and Oster 1998)
– Nobel-Prize-winners (Weinberg & Galenson 2005)
• “Conceptual” laureates: 43
• “Experimental” laureates: 61
Our findings:
• Financial “performance” rises then declines with age
• Performance:
– negotiate low (borrowing) interest rates
– pay fewer fees
• This regularity is confirmed for 10 separate types of
financial choices
• On average, financial performance peaks at age 53
(1,2) Home Equity Loans and
Home Equity Credit Lines
• Proprietary data from large financial institutions
• 75,000 contracts for home equity loans and lines of
credit, from March-December 2002
• We observe:
– Contract terms: APR and loan amount
– Borrower demographic information: age, employment status,
years on the job, home tenure, home state location
– Borrower financial information: income, debt-to-income ratio
– Borrower risk characteristics: FICO (credit) score, loan-to-value
(LTV) ratio
Home Equity Loan APR by Borrower Age
6.50
6.00
5.75
5.50
5.25
Borrower Age (Years)
80
77
74
71
68
65
62
59
56
53
50
47
44
41
38
35
32
29
26
23
5.00
20
APR (Percent)
6.25
Home Equity Credit Line APR by Borrower Age
5.50
5.00
4.75
4.50
4.25
Borrower Age (Years)
80
77
74
71
68
65
62
59
56
53
50
47
44
41
38
35
32
29
26
23
4.00
20
APR (Percent)
5.25
(3) “Eureka”: Learning to Avoid Interest
Charges on Balance Transfer Offers
• Balance transfer offers: borrowers pay lower APRs on
balances transferred from other cards for 6-9 months
• New purchases on card have higher APRs
• Payments go towards balance transferred first, then
towards new purchases
• Optimal strategy: make no new purchases on card to
which balance has been transferred
Eureka: Predictions
• Borrowers may not initially understand card terms
• Borrowers learn about terms through usage
– We will see “eureka” moments: new purchases on
balance-transfer cards drop to zero in the month after
borrowers “figure out” how to optimize
• Study: 14,798 balance transfer accounts over the period
January 2000 to December 2002
Fraction of Borrowers in Each Age Group
Experiencing a Eureka Moment, by Month
Month One
Month Three
Month Five
No Eureka
Percent of Borrowers
60%
50%
Month Two
Month Four
Month Six
40%
30%
20%
10%
0%
18 to 24
25 to 34
35 to 44
45 to 64
Borrower Age Category
Over 65
(4,5,6) Fee payments
• We examine payments of three types of credit card fees:
– Late payment fees
– Over credit limit fees
– Cash advance fees
• We again see U-shaped patterns by age
• The opportunity cost model (younger and older adults
have more time to avoid fees) would predict the opposite
pattern
• 3.9 million month-borrower observations on credit card
purchases from January 2002 through December 2004
Frequency of Fee Payment by Borrower Age
0.33
0.31
0.29
0.27
0.25
Late Fee
0.23
Over Limit Fee
0.21
Cash Advance Fee
0.19
0.17
0.15
20
23
26
29
32
35
38
41
44
47
50
53
56
59
62
65
68
71
74
77
80
Fee Frequency (per month)
0.35
Borrower Age (Years)
(7) Auto Loans
• Proprietary data from several large financial institutions
• 6,996 loans for purchase of new and used autos
• We observe:
– Contract terms: APR and loan amount
– Borrower demographic information: borrower age
and state of residence
– Borrower financial information: income, debt-toincome ratio
– Borrower risk characteristics: FICO score
– Automobile characteristics: value, age, model, make
and year.
Auto Loan APR by Borrower Age
9.50
9.00
8.75
8.50
8.25
8.00
20
23
26
29
32
35
38
41
44
47
50
53
56
59
62
65
68
71
74
77
80
APR (Percent)
9.25
Borrower Age (Years)
(8) Credit Card APRs
• Proprietary data from a large financial institution that
issues credit cards nationally
• 128,000 accounts over a 36 month period from 1/2002 to
12/2004
• We observe:
– Card terms: APR, fees paid
– Borrower risk information: FICO (credit) score, card balances,
other debt
– Borrower demographic information: age, gender, income
Credit Card APR by Borrower Age
18.50
18.00
17.75
17.50
17.25
17.00
20
23
26
29
32
35
38
41
44
47
50
53
56
59
62
65
68
71
74
77
80
APR (Percent)
18.25
Borrower Age (Years)
(9) Mortgage APRs
• Proprietary data from a large financial institution that
originates first mortgages in Argentina
• 4,867 fixed-rate, first-mortgage loans on owner-occupied
properties between June 1998 and March 2000
• We observe:
– Contract terms: APR and loan amount
– Borrower demographic information: age, employment status,
years on the job, home tenure, home location
– Borrower financial information: income, debt-to-income ratio
– Borrower risk characteristics: Veraz (credit) score, loan-to-value
(LTV) ratio
Mortgage APR by Borrower Age
13.00
12.50
12.25
12.00
11.75
11.50
20
23
26
29
32
35
38
41
44
47
50
53
56
59
62
65
68
71
74
77
80
APR (Percent)
12.75
Borrower Age (Years)
(10) Small Business Credit Card APRs
• Proprietary data set from several large financial
institutions that issue small business credit cards
nationally
• 11,254 accounts originated between 5/2000 and 5/2002
• Most businesses are small and owned by single families
• We observe:
– Credit card terms: APR
– Borrower demographic information: age
– Borrower risk information: credit score, total number
of cards, total card balance
– Business information: years in business
Small Business Credit Card APR by Borrower Age
16.00
15.50
15.25
15.00
14.75
14.50
20
23
26
29
32
35
38
41
44
47
50
53
56
59
62
65
68
71
74
77
80
APR (Percent)
15.75
Borrower Age (Years)
U-shape for financial mistakes in 10 examples
–
–
–
–
–
–
–
–
–
–
Home equity loans
Home equity lines of credit
Eureka moments for balance transfers
Late payment fees
Over credit limit fees
Cash advance fees
Auto loans
Credit cards
Small business credit cards
Mortgages
US: Rising Role of DC Plans
Private-Sector Workers
Pension type (as a proportion of all pensioned workers)
70%
50%
30%
10%
1979
Only
Only
1990
2004
Breakdown of Retirement Assets in
US Market (year-end 2007)
Total US Retirement Assets:
$17.4 trillion
Pension plans for
Government Employees:
$4.4 trillion
Private pension plans:
$13.0 trillion
DB Assets:
$2.4 trillion
Source: ICI, December 2007
Other Assets:
$10.6 trillion
IRA: $4.6 trillion
DC: $4.4 trillion
Annuities: $1.6 trillion
Most Retirement Savings is in
Individual Accounts
Total US Retirement Assets:
$17.4 trillion
All DB Pensions
$4.6 trillion
Source: ICI, December 2007
Individual accounts:
$12.8 trillion
$100 bills on the sidewalk
Choi, Laibson, Madrian (2004)
• Employer match is an instantaneous, riskless return on
investment
• Particularly appealing if you are over 59½ years old
– Have the most experience, so should be savvy
– Retirement is close, so should be thinking about saving
– Can withdraw money from 401(k) without penalty
• We study seven companies and find that on average, half of
employees over 59½ years old are not fully exploiting their
employer match
– Average loss is 1.6% of salary per year
• Educational intervention has no effect
Conclusion
• U-shape for mistakes in all 10 examples
• Others have confirmed this pattern in their data sets:
– Fiona Scott-Morton (auto loans)
– Luigi Guiso (portfolio choice)
– Lucia Dunn (credit cards)
• Implications for public policy
– 401(k)’s
– IRA rollover accounts
– Annuitization
– Medicare, especially Part D
– Social Security Privatization
– Regulation of financial advisors