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June 08, 2016 at 01:12 PM
Advisors are familiar with the “nudge economics” features in defined contribution plans that encourage participation – automatic enrollment, target-date funds – and help investors overcome inertia and procrastination. However, without an improvement in financial literacy to accompany those features, investors will still struggle to meet their retirement objectives, according to a paper for Principal Global Investors by Professor Amin Rajan, chief executive of CREATE-Research, an independent research boutique.
As retirement risk is increasingly borne by individuals in DC plans, rather than by defined benefit sponsors, it’s given rise to an “’employee as a retirement planner’” model, Rajan wrote. Now, “Managing retirement savings requires a proactively engaged individual who is capable of accessing the right information, robustly processing it, making rational decisions, monitoring the outcomes and making the necessary course corrections.”
A 2015 study by Standard & Poor’s Ratings Services gave U.S. investors a financial literacy rate of 57%. State Street’s Center for Applied Research found in 2014 that the average financial literacy score for 16 countries was 61%, a D. The U.S. had a below-average score of 60%, while the top scorer, Singapore, squeaked by with 70%.
Rajan acknowledged that investing is complex, and wrote that the goal of financial literacy initiatives isn’t to create full-fledged financial planners but to “help investors to sidestep some of the basic traps in retirement planning that are so common in all pension jurisdictions.”
A 2011 National Bureau of Economic Research Working Paper found that answering just one more financial question correctly increased the likelihood that the individual was planning for retirement by three or four percentage points. It’s not that retirement savers have to be good at math either; the Institute of Law and Economics at the University of Pennsylvania found in 2015 that retirement saving was more closely linked to a basic understanding of the relative costs and benefits of the major asset classes.
Rajan identified three main obstacles to retirement saving in the United States: increasing participation, increasing deferral rates and improving investors’ asset allocations.
