Data & Research April 21, 2008

Confusion About Financial Jargon Preventing Decisions

One in six Americans have not signed up for their company’s retirement plan because they don’t understand how it works, and 44% don't understand how an individual retirement account (IRA) account works.
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Partly due to this confusion, 19% of respondents to a survey of 1,203 adults by AARP Financial Inc said they are very confident they will have enough money to live comfortably in retirement.

More than half (52%) of the adults surveyed said they’ve made an investment mistake because they were “confused” by or “didn’t understand” an investment. The most common two mistakes cited were failing to or waiting too long to invest because of confusing information (cited by 30%) and making an investment they regretted because they didn’t understand it (28%).

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Financial Services Industry Doesn’t Make the Grade
Two-thirds of survey respondents gave the financial services industry a “C”, “D” or “F” when asked to grade it on how well it explains saving and investing to consumers – worse than car mechanics and doctors. In fact, 73% of those surveyed believe financial professionals use more jargon than their car mechanic and 52% say financial professionals use more jargon than doctors.

Unfortunately, many Americans surveyed said that poor communication is intentional:

  • Over half (54%) believe that a major reason jargon is used instead of simpler terms is to distract people from focusing on the fees they will be paying;
  • 78% said they believe that materials from financial companies are more about selling than educating;
  • 63% say that a major reason jargon is used is to make a product or service seem more impressive;
  • 49% believe a major reason jargon is used is to make the consumer feel less confident that they can handle their own finances.

“These findings are a call to action for the financial services industry,” Richard Hisey, chief investment officer at AARP Financial said. “Ultimately, no one is well-served by this confusion — not the industry, not consumers and certainly not our relationship with the investing public. We talk a lot about transparency in this industry but not enough about simplification and understanding. What value does disclosure bring if the average investor can’t comprehend?”

Confusing Information Prevalent
Almost half (41%) said information from financial services companies is “not so” or “not at all” helpful. Also, more than half of those surveyed (54%) said they do not read financial literature because “it’s too hard to understand.”

Not surprisingly, half of those surveyed described themselves as “not so” or “not at all” knowledgeable about investing and less than one-third of those surveyed said they understood the terms “basis point,” “expense ratio,” or “index fund” well enough to explain them to a friend or co-worker. In comparison to other communications, 82% said their car insurance policy is easier to understand than a mutual fund prospectus, and 79% find prescription drug inserts easier to understand.

IMHO April 19, 2008

IMHO: The Sum of Its Parts

Last week, the House Committee on Education and Labor passed the 401(k) Fair Disclosure for Retirement Security Act (H.R. 3185).
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That it passed was no surprise (it did so along party lines, and it is, after all, a bill sponsored by the chairman of that committee, Congressman George Miller (D-California)).
The issue that seems to loom largest in the minds of those paying attention is the requirement that all service providers break down their charges into four specific categories: administrative fees, investment management fees, transaction fees, and other fees. This isn’t a big deal for many, perhaps most—and it’s a lot simpler than the first version of the bill. Still, a number of bundled providers are claiming that it will be a burden for them to determine what that breakdown is, that the process of discovering—and communicating—those figures will cost money, and, at some point, that it doesn’t make sense because those services aren’t available from them at an à la carte pricing.
A stronger case can perhaps be made that these disclosures will amount to naught; that participants won’t read or understand them—or have any frame of reference. Plan sponsors are concerned that the disclosure will simply generate more participant concern and/or confusion, and potentially provide some with an excuse to defer or forego participating in the plan, and I think there are merits in all these concerns. Still, it seems unlikely that the Miller bill will go anywhere, certainly not in the short-term (it’s an election year, after all)—and the Department of Labor is well into the process of setting out its own proposals on enhanced fee disclosures.
Adults Education
But I think—and I’ve said this before—that it’s time we started treating participants like adults. We need to tell them the truth about retirement expenses, we need to be blunt about the realities of their current savings patterns, and they need to understand that these services we work so hard to provide have a cost. And, IMHO, the advent and widespread embrace of “automatic’ plan features makes that honesty more critical than ever.
In that spirit, and regardless of what we wind up with on the regulatory or legislative front—or when—I think it’s time we insist on the following:
  • Every plan sponsor should receive—today—a detail of the fees paid by their plan—and, IMHO, the breakdown articulated in the Miller bill is a good framework. Bundled providers can surely provide estimates, if nothing else. You can’t fulfill your fiduciary duty to ensure that fees and services are reasonable if you don’t know what the fees for those services are.
  • Every plan sponsor should receive some idea of the fees paid by participants in their plan. You don’t have to see the Miller bill as inevitable to know the day is coming when we’re going to HAVE to tell participants what they are paying in a more explicit way. Worst case—take the detail above and divide it by the number of participants; or take the total plan fees, divide it by the total plan market value, and multiply it by the individual account balances. You might be surprised how close that will get you (certainly if the fees are largely asset-based).
Now, assuming that their plan adviser has—or will take —a leadership role in attaining those two results, I think it’s time to give plan sponsors and, eventually, plan participants one more thing: something with which to compare that result. Other, comparable 401(k) plans would be good—but why limit it? Why not compare it with the account fees, transaction charges, and retail share-class charges participants would pay if they truly did it on their own?
Many have been worried that participants would be put off by knowing how much these programs really cost—some in Congress clearly think participants are getting ripped off. It may be naïve, but I still think most are getting a real bargain—they just don’t know how good they have it.

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