MRRC Newsletter
Page 5

Summary of Major Findings

  • Sixty percent of all answers to the probability questions were imprecise answers (respondents answered that an event had a 0, 50 or 100 percent chance of happening).
  • Probabilistic thinking is strongly related to age and education such that older people and less educated people tend to be less competent probabilistic thinkers, that is, they are more likely to give imprecise answers (0, 50, or 100 percent) to the probability questions.
  • Households with people who are very likely to give precise answers--are very good probabilistic thinkers--have a significantly larger proportion of risky assets in their financial portfolio. This effect takes into account the effect of education and age as well as other demographic and financial factors.
  • When we examine the effect of probabilistic thinking on the growth rate of those assets, we find that households with people who are good probabilistic thinkers experienced a significant and very large rate of growth of assets from 1992 to 1998 compared to households where individuals tended to be less precise, or poorer probabilistic thinkers. In this model, the control for education has a large effect and cuts the relationship between probabilistic thinking and asset growth in half. Further investigation of this finding suggests that education is likely related to some other measure of cognitive ability that we were not able to measure.

This study was motivated by the question of how well older Americans will be able to take advantage of individual private retirement investment accounts—programs that expand the scope of individual choice in decision-making. We have focused our attention on one aspect of financial decision-making—probabilistic thinking—that is important for financial decision-making. We believe that this paper provides clear evidence that there is a wide range of competence in probabilistic thinking in the older population and that more precise beliefs lead households to be willing to take more risks and to enjoy higher growth in wealth. An important caveat, however, is that this study is the first of its kind. Furthermore, we believe it is important for future work to explore the extent to which people can reduce uncertainty, become more confident and precise thinkers, through experience with financial management, and hence become better able to manage their finances in ways that will be most beneficial to them.

Robert J. Willis is Professor of Economics and is the Principal Investigator of the Health and Retirement Study (HRS) at the University of Michigan Institute for Social Research (ISR). Lee Lillard was a Professor of Economics and the Director of the Michigan Retirement Research Center (MRRC) at University of Michigan Institute for Social Research (ISR). Dr. Lillard died on December 2, 2000. This research was supported by a grant from the Social Security Administration to the Michigan Retirement Research Center (UM 00-04). Data from the Health and Retirement Study used in this paper were funded by the National Institute of Aging (AG09740), with additional support from SSA. We are grateful for research assistance by Gabor Kezdi, Jody Schimmel, and Helena Stolyarova. We are also grateful for comments on earlier versions of this paper by workshop participants at the University of Michigan, the University of Bergen, Northwestern University, and the TMR Conference-Paris, the University of Chicago, and discussions with Gary Becker, Jim Heckman, Chuck Manski, Sol Polachek, Sherwin Rosen, Mark Rosenzweig, Matthew Shapiro, Jim Smith, and Yoram Weiss.
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