Many individuals enrolled in DC plans lack basic financial knowledge. No surprise there.
But as the shift from DB to DC continues, resulting in increased responsibility on individuals to make sound decisions on saving for retirement, the need for increased financial education is becoming more and more obvious.
New research from the FINRA Investor Education Foundation (FINRA Foundation) and the Global Financial Literacy Excellence Center (GFLEC) at the George Washington University School of Business shows investors with “alarmingly low” levels of financial knowledge lack confidence in their ability to meet their financial goals.
“Investors are seeing a rapid evolution of the financial landscape, from the introduction of more complex financial products and instruments to a fundamental shift in the retirement system that places responsibility for saving and investing squarely on the shoulders of individual Americans,” says Gerri Walsh, President of the FINRA Foundation. “Fewer workers today have defined benefit pension plans and the rise of defined contribution plans, like 401ks, require an understanding of financial markets and basic personal finance that many investors lack.”
The study, titled, New Evidence on the Financial Knowledge and Characteristics of Investors, examined nearly 15,000 Americans, aged 25 to 65, who were not retired or in school. Investors were categorized into two segments, workplace-only investors and active investors, though the study also included non-investors for comparison purposes.
Workplace-only investors had retirement accounts only through their employers, and did not have any other type of retirement accounts or any other financial investments in stocks, bonds, mutual funds or other securities.
Active investors had private retirement accounts they had set up themselves and/or financial investments in stocks, bonds, mutual funds or other securities, though most also had accounts through their employer, as well.
The study found significant differences between workplace-only investors and active investors, perhaps most strikingly the level of financial literacy. Higher levels of financial knowledge was associated with much greater participation in private retirement savings accounts and financial markets.
Among workplace-only investors, 28% were offered financial education by a school or college or a workplace where the investor was employed. By contrast, 42% of active investors were offered financial education.
“Many investors, and especially those who are exposed to investment decisions solely through participation in an employer-sponsored retirement plan, lack financial literacy,” says Annamaria Lusardi, Academic Director of GFLEC. “This is a problem that cannot be overlooked. Our findings signal a great need for targeted financial education programs that raise financial knowledge, particularly in the workplace. Workplace education could help prepare employees for the sort of financial decision making that they are required to make.”
As the expansion of defined contribution retirement plans continues, researchers cited an increasing need for financial education, particularly through the workplace.
Auto-enrollment at odds with financial literacy?
The study’s authors note that low financial knowledge levels among workplace-only investors might reflect the impact of the rise in automatic enrollment among employer-sponsored retirement accounts over the past decade, particularly among large companies. Workplace retirement savings plans that feature automatic enrollment typically require participants to make few or no active choices about their retirement account investments.
The NFCS does not measure the extent to which workplace-only investors were auto-enrolled, but says the findings show a striking difference in financial knowledge across investors and overall low levels of financial literacy.
The report concludes that workplace education could be a useful way to reach a large share of the adult population and help prepare employees for the sort of financial decision making that they are required to make. Further, employer-sponsored retirement plans may have the additional benefit of serving as an on-ramp to investing in taxable investment accounts.
An effective financial education program, the study says, should take into account the employees’ financial situation and follow an integrated approach that considers both assets and debt rather than focusing only on retirement savings.
Given the alarmingly low levels of financial literacy across the entire population, programs using clear, jargon-free language and well-structured action plans are more likely to increase engagement and result in positive behavioral change.
More key findings
- Workplace-only investors were more likely to include individuals who were divorced or separated, had lower incomes and less education, and were less likely to be self-employed. Women comprised 53% of workplace-only investor group compared to 38% of women among active investors.
- Knowledge of basic financial concepts across investor groups was alarmingly low, but workplace-only investors knew much less than active investors. When presented with financial literacy questions that measured understanding of interest rates, inflation and risk diversification—known as the Big Three rudimentary financial concepts—only 32% of workplace-only investors could answer the questions correctly, compared to 44% of active investors.
- Investors had significant difficulty answering questions connected to two areas of investment decision-making—asset pricing and risk diversification. Only 25% of workplace-only investors could correctly answer the asset pricing question, while 35% of active investors correctly answered this question. The same pattern held for the risk diversification question, which was correctly answered by 46% of workplace-only investors and around 60% of active investors.
- The ability to make ends meet, debt, perceptions of financial well-being and the ability to withstand financial shocks are related to an investor’s decision to invest in financial markets and to save for the long-term. Workplace-only investors were much more likely (49%) to have difficulties covering expenses and paying bills in a typical month compared to around one-third among active investors (38%).
- The willingness to take financial risks is much higher among active investors (36%) as compared to workplace-only investors (17%). In the general population one-third (33%) of men but just 12% of women are willing to take financial risks.
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.
