Numerous national studies have indicated that Americans suffer from a lack of financial literacy. Beyond the basics of balancing a checkbook (20th century) to understanding fees on debit and charge cards (21st century), Americans are generally not particularly wise in the ways of handling money.
There is a segment of investors who hand their money over to financial advisors and instruct them to make all the investment decisions. That is a fair description of people who invest funds in defined contribution plans like 401(k)s; those people often have no idea how their invested amount grows.
According to Spectrem’s new DC Participant Insight Series study Educating Defined Contribution Participants, there is a frightful lack of financial education among investors who participate in defined contribution plans. It raises all sorts of questions about whether these DC plan participants understand how their contributions manage to grow, and what they are investing in when they agree to make a defined contribution.
A remarkably high 52 percent of DC participants claim to be not very knowledgeable or not at all knowledgeable about finance and investing. These are people who are investing, by putting funds into a defined contribution plan. But they admit they do not know much about how investing works.
The lack of knowledge among defined contribution plan participants could be a result of a lack of education. Only 15 percent of DC participants have ever taken a financial literacy course, in high school, college or elsewhere. That percentage is consistent through age groups, although 22 percent of males say they have taken such a course to just 9 percent of females.
The greater the account balance in the DC plan, the more likely the investor has taken a financial literacy course. For example, 38 percent of DC plan participants with an account over $750,000 have taken a financial education course. The question, however, is whether the education came first, or the large account did.
The investors surveyed for the DC study were given a financial literacy quiz to determine the extent of their financial and investment knowledge or lack thereof. It did not go well from an A grade to F grade standpoint.
Considering a C grade to be 70 percent correct and a C grade to be the lowest possible “passing’’ grade, only 20 percent of defined contribution plan participants “passed”. In fact, 68 percent of the investors answered fewer than half the questions correctly.
The test results were also segmented, and younger investors performed the most poorly, with 75 percent failing to answer half the questions correctly. Perhaps more telling was that 81 percent of female DC plan participants answered fewer than half the questions correctly.
It is not the job of financial advisors to complete a financial literacy education program for investors who perhaps should have learned some of the material in high school or college. But it would be beneficial for investor clients to understand some of the terms advisors use to describe investment products, and it would be beneficial to financial advisors for their clients to understand what they are investing in when they make defined contributions.
Advisors can help investors determine where to get information on their defined contribution portfolio, and can assist them in determining what questions they need to ask to understand their investments.
©2019 Spectrem Group