Retail investors—particularly minorities and the elderly—lack basic financial literacy skills, with many of them failing to understand financial concepts such as compound interest, inflation, diversification, or the differences between stocks and bonds, and investment costs and their impact on investment returns, according to a just-released financial literacy study by the Securities and Exchange Commission (SEC) and the Library of Congress.
The study, released Thursday, was mandated by the Dodd-Frank Act and not only gauges retail investors’ financial literacy skills, but it also describes what investors want to know about financial professionals and investment products and services, as well as when and how investors want to receive such information.
To help understand where retail investors stand in terms of financial literacy, the SEC contracted with the Library of Congress to conduct a review of the quantitative studies on the financial literacy of U.S. retail investors published since 2006. The Library of Congress delivered its own report to the SEC, finding that American investors lack basic financial literacy, including critical knowledge about investment fraud.
Investors, the Library of Congress report said, have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud. Further, certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population and those who are poorly educated, have an even greater lack of investment knowledge than the average general population.
The Library of Congress Report concludes that “low levels of investor literacy have serious implications for the ability of broad segments of the population to retire comfortably, particularly in an age dominated by defined-contribution retirement plans.” Furthermore, the study states that “intensifying efforts to educate investors is essential” and that investor education programs should be tailored to specific subgroups “to maximize their effectiveness.”
In response to the Dodd-Frank mandate under Section 917(a)(1) of the Act, which calls for the agency to study the existing level of financial literacy among retail investors, the SEC’s Office of Investor Education and Advocacy published a request for public comment and data to inform its study and received 45 unique comments from, among others, investors, financial professionals, industry groups, consumer advocates, academics and other regulators.
The SEC study identifies investor perceptions and preferences regarding a variety of investment disclosures, and shows that investors prefer to receive investment disclosures before investing, rather than after, as is common practice among many investment products purchased today.
Among the information that investors said they find useful and relevant in helping them make informed investment decisions is information about fees, investment objectives, performance, strategy and risks of an investment product, as well as the professional background, disciplinary history and conflicts of interest of a financial professional. Investors also favor investment disclosures presented in a visual format, using bullets, charts and graphs.