In the employer-sponsored retirement plan arena, poor understanding of financial terms is not the fault of 401k plan participants. This jargon is difficult to understand. And the industry sometimes needs complex language for complex concepts. What to do?
New research says maybe it’s time to change the framework.
Workplace plans could consider building solutions that don’t require people to know complex financial terms to achieve financial security, for example, or strengthening QDIAs. Explore models that simplify choices on a higher-level without diving into depths of EFTs and other product details.
These are among the conclusions in a new report by Hearts & Wallets, a research and benchmarking firm that specializes in how consumers save, invest and seek financial advice.
Titled, “Financial Fluency: What Consumer Understanding of the Language of Finance Means for Advice, Retirement and Asset Management,” the report examines consumer understanding of the language of investing, the connection to financial needs and behaviors, and the implications for advice, workplace retirement and asset management businesses.
“Many surveys assess consumer financial literacy,” Laura Varas, CEO and founder of Hearts & Wallets said. “Our goal was to extend the conversation into investing. Lack of understanding of the words that plan participants need to make decisions has implications for our national retirement system and improving plan design.”
The report found that in a national survey of nearly 6,000 U.S. households, 81% of Americans failed a quiz of key investing terms, and one in three of potential participants in workplace retirement plans do not know any definitions for four basic investment selection terms.
Only 19% of Americans achieved a passing grade, selecting the best answer for five or more terms. The terms were divided into four basic investment selection terms and three more advanced terms.
Clear definitions matter
The research shows clear definitions matter when it comes to financial terms. Consumers confused over the definition of “passive investing,” for example, save less and use fewer investment products. For the term “passive investing,” half (51%) of all consumers selected “don’t know” rather than one of the two definitions.
Adding to the confusion, among consumers who chose a definition, more consumers selected the definition that differs from the one touted by large financial services firms. Nearly one third (29%) of consumers picked “buying and holding without being influenced by short term market fluctuations” while 20% selected “investing in an index, often weighted to market capitalization.”
A Hearts & Wallets analysis finds most established investing companies, including market share leaders in index fund management Vanguard, Fidelity and BlackRock, tend to use the technical “indexing” definition of passive investing vs. the more intuitive definition of “buy and hold” preferred by consumers.
“Consumers, financial services firms and advisors should speak the same language,” Beth Krettecos, Hearts & Wallets Subject Matter Expert, said. “An intuitive definition will often take on a life of its own, as shown with the term, ‘passive investing.’ Firms may want to use a more description term, like ‘indexing,’ to avoid misunderstanding. Where complex choices require technical language for explanation, firms may want to consider introducing new, more intuitive concepts to help consumers become more confident about investing.”
Who speaks the language
Language barriers may also deter eligible participants from plan participation. More Americans who are eligible but not participating do not know the best definition for any of the terms vs. participants (38% vs. 29%). Millennials and women are among the groups that need the most help in understanding basic concepts fundamental to their ability to select investments within plan.
Workplace programs, as currently structured, do not improve fluency with basic investment selection terms. Only 28% of consumers who use workplace resources as their “go-to/primary” source of investing information and advice know three-plus terms.
Fluency is much higher for consumers with higher education levels. Being a consumer of advice also helps. Consumers who use paid investment professionals as their “go-to/primary” or usual sources of investing information and advice are more likely to know the best definitions for five-plus terms. Conversely, three in 10 consumers (30%) who identify as self-directed investors did not know the best definition for even one term. The survey found men have a better understanding than women across all asset levels.
SEE ALSO:
- Most Americans Get ‘F’ on Financial Literacy Test
- Better Personal Finances Means More Productive Employees
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
