Background: An age-related decrease in functional capacity is consistently reported, but it is not consistently related to a worsening of health-related quality of life (HRQOL) or psychological adjustment. A poor functional capacity and HRQOL have been associated with anxiety or depression, but the possible causal nature and direction of the relationship remain to be explored using long-term longitudinal data. Objective: The purpose of this study was to examine age-related changes in functional capacity, HRQOL, and scores on the Hospital Anxiety and Depression Scale (HADS), and possible causal interrelationships between these variables. Methods: Study participants were 5,124 Japanese aged ≥65 years. After the baseline study (2003), annual follow-up observations continued for 10 years. Generalized linear mixed models examined age-related changes in Barthel index (BI), Tokyo Metropolitan Institute of Gerontology Index of Competence (TMIG-IC), HRQOL, and HADS. Cross-lagged effects models tested possible causal interrelationships. Results: With age, functional capacity and HRQOL scores showed similar declines in both sexes. Changes in mental health, anxiety, and depression developed more slowly than decreases in physical health (BI, TMIG-IC, and physical functioning scores). Cross-lagged effects models demonstrated that functional capacity had positive effects on psychological adjustment, and that psychological adjustment had positive effects on functional capacity 5 years later. Interactions between functional capacity and psychological adjustment showed no sex differences. A decline in functional capacity negatively affected psychological adjustment, but reduced psychological adjustment had no significant impact on functional capacity 5 and 10 years later. Moreover, functional capacity and poor psychological adjustment showed no interactions in either sex. Conclusion: Functional capacity and mood state are interrelated. Greater function could sustain vitality and mental health, possibly reducing anxiety and depression.