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Financial Planning > Behavioral Finance

Quiz Time: Do Investors Understand How Financial Services Really Works?

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Some 15 years ago, or so, a veteran financial planner told me that he didn’t take on new clients who were under 50 years old. He had created this rule, he told me, after years of experiencing younger clients constantly challenging his advice with their own “knowledge” and/or “experience,” resulting in a higher than average turnover rate among younger clients. “Until clients are 50 or so,” he told me, “they haven’t made enough mistakes, and had enough bad ‘advisor’ experiences, to realize how much they don’t know. They just aren’t ready to take advice.”

Since that time, I’ve raised the issue with a number of other veteran advisors, and found quite a few who have similar rules about taking “younger” clients; give or take a few years. This is one of the reasons that I’ve been skeptical about all the recent hoopla over “the need” for independent advisors to attract Millennials (ages 21 to 36) as clients (see my last blog; Is the Future of Financial Advice as Dim as Millennials’ Finances?). 

That blog was about a white paper released by big four accounting firm PwC (formerly Price Waterhouse Coopers) on the present state of Millennials’ finances. By way of follow up, I asked the folks at PwC to send me the data on Millennials’ financial literacy, which had been referenced in the study as being equally as dismal as Millennials’ financial lives. The actual data doesn’t disappoint and raises two important questions for the advisory community:

1) How important is “financial literacy” to good advisor/client relationships?

2) what kind of “financial literacy” would improve client relationships?”

To determine the “financial literacy” of Millennials, the PwC study used data collected by the George Washington University Global Financial Literacy Excellence Center in its 2012 National Financial Capability Study, which asked some 5,525 Millennials five basic financial questions:

1) Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

a) More than $102
b) Exactly $102
c) Less than $102
d) Don’t know
e) Prefer not to say

2) Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?

a) More than today
b) Exactly the same
c) Less than today
d) Don’t know
e) Prefer not to say

3) Buying a single company’s stock usually provides a safer return than a stock mutual fund.

a) True
b) False
c) Don’t knowd) Prefer not to say

4) A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.

a) True
b) False
c) Don’t know
d) Prefer not to say

5) If interest rates rise, what will typically happen to bond prices?

a) They will rise
b) They will fall
c) They will stay the same
d) There is no relationship between bond prices and the interest rate
e) Don’t know

According to the Survey, “Individuals are considered to have a basic level of financial literacy if they answered the first three question correctly; and an advanced level of financial literacy if they answer all five questions correctly.” (In case you’re playing along at home, the answers are: a,c,b,a,b.)

How did the Millennials do?

Of the sampling, 24% of them answered the first three questions correctly; and only 8% of them correctly answered all five.

I think we can all agree that these questions don’t involve quantum physics, or are as important as knowing, say, the Kardashian sisters’ dress sizes (I’ll leave the inclusion of Caitlyn Marie to your discretion).

I suspect that it would save some time if advisory clients had at least some understanding of basic financial principles. Yet I can’t help but wonder if the above knowledge would really improve advisor/client relationships, or whether both clients and advisors would benefit more from a different kind of “literacy.”

It seems to me, at least in America today, that financial services are sufficiently complex (intentionally so), that even possessing “basic financial literacy” would only give investors a false confidence that they understand how it all works. Instead, what investors and advisory clients really need is “financial services literacy:” that is, an understanding of how the financial services industry really works—and how they and their advisor fit into it. 

Toward that end, here are a few questions that might help investors and/or advisory clients increase their financial services literacy: 

1) Which of the following “advisors” have a legal duty to put their clients’ interest ahead of their own interests and the interests of their employer: 

Insurance Agents
Registered Investment Advisors
All of the above

2) Which of the following are ways that some financial advisors get paid:

Asset management fees
Financial Planning Fees
Referral Fees
Annual bonuses
Higher payouts
All of the above

3) Which of the following are ways some financial services firms get paid on their clients’ investments:

Asset management fees
Financial Planning fees
Overhead Expenses
Marketing Fees
Due Diligence Fees
Marketing Costs
Trading Costs
Trading Spreads
All of the above

4) Which of the following advisory relationships require resolving client disputes with arbitration rather than in courts of law?

Registered Investment Advisors
Insurance Agents
All of the above

5) Which of the following advisors have a legal duty to eliminate or minimize their conflicts of interest rather than simply disclosing them?

Registered Investment Advisors
Financial Planners
Insurance Agents
All of the above

6) Which of the following kinds of investment accounts legally require the advisor to act solely in the interest of the client?

Brokerage accounts
Asset management accounts
401(k) accounts
All of the above

It seems to me that understanding these questions and answers would give investors a much better chance of financial prosperity than knowing how interest rates affect bond prices. They might also initiate discussions that would greatly improve the relationships between independent advisors and their clients. 


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