Data & Research April 23, 2012

Financial Literacy Is Key Component of Retirement Planning

Older Americans aren’t that literate when it comes to finance, which could have a negative impact on their ability to plan successfully for retirement.
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The older Baby Boomers are not particularly financially literate, a study finds—and they’re easily tripped up by wording.

Financial sophistication is a weak spot for older respondents age 55 and older, according to research from the Pension Research Council. While other studies have looked at basic financial literacy, Olivia Mitchell and Annamaria Lusardi examined both financial literacy and financial sophistication among older Americans. 

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In “Financial Sophistication in the Older Population,” Mitchell and Lusardi— the Pension Research Council’s director and a professor of insurance and risk management at The Wharton School, and a professor of economics at Dartmouth College, respectively­—found that many Americans over age 55 lack a basic grasp of asset pricing, risk diversification and investment fees. Specific subgroups among older Americans include women, people over the age of 75 and those who are least educated.

At a time when people are increasingly being asked to take on responsibility for their own retirement security, such lack of knowledge can have serious implications, Mitchell and Lusardi said. Americans are more and more likely to hold individual retirement accounts such as IRAs or 401(k) plans, accumulate privately held assets, and hold debt, meaning that most people will need a certain amount of financial sophistication to be able to manage assets and debts sensibly over their lifetimes.

 

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Consumer financial illiteracy can have important consequences—those who lack literacy are much less likely to plan for retirement; are more likely to end up with little wealth close to retirement; are less likely to invest in stocks; and they tend to use high-cost borrowing channels. More literate individuals, on the other hand, are more likely to choose mutual funds with lower fees.

It’s not just the true-or-false questions themselves, but the way they are worded that is significant, Lusardi and Mitchell found.

While 73% were aware that “Even if one is smart, it is very difficult to pick individual stocks that will have better-than-average returns,”  when the question was reworded to “If you are smart, it is easy to pick individual stocks that will have better-than-average returns,”  only 38% answered correctly.

The findings can be useful in designing financial education programs that help participants save and make informed investment choices. The paper is also helpful in determining which questions (and the way they are phrased) are most important in predicting financial literacy.


 

 

Data & Research April 23, 2012

Time to Start Wooing the Next Generation of Investors

 

 

Savvy broker/dealers need to start understanding how to win the next generation of investors, an industry analyst said.

 

 

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 In the financial services industry, young is relative. Typically it means middle-aged investors between the age of 35 and 55. Investors in this age range size up surprisingly well against their older counterparts in terms of addressable retirement savings and overall wealth. As a group, they control $10.2 trillion in investable assets and 659,000 are considered affluent or wealthier. This compares with $16.6 trillion controlled by households who are 56 years of age or older, of which 1.5 million households are considered affluent or wealthier, reports Cerulli Associates. 

Younger investors are excellent targets for asset managers and distributors, but many have not yet hired their first adviser. On average, their wealth is still below that of their older peers, and some distributors may see them as less attractive. But the choices these investors make will determine which models of advice survive and which will struggle to adapt, according Cerulli Associates research.

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While still a far-off concern, firms should begin thinking about the next generation of wealth. They should consider the average age of their client base and look for changes over time.

“Those firms who intend to wait until the next generation of wealth ages and build assets may face greater competition in acquiring clients,” says Katharine Wolf, associate director at Cerulli Associates. “Other advice providers may have already acquired the next generation of clients and, if those providers can keep these clients happy, the clients may have no impetus to seek another provider.”

 

Firms that take a wait-and-steal-wealthy-clients approach will face greater competition, as other providers add more advice services. Direct providers, for example, have retooled their advice services over the last few years. These firms have an advantage in that advice-seeking investors often reach out to them on the investor's pre-existing relationships via a 401(k) plan or smaller retail account. While they won't necessarily steal clients away from traditional adviser channels, direct firms are becoming better at retaining clients who may otherwise seek outside advice.

"By offering advice, direct firms may slow the stream of clients who seek a traditional adviser in the first place, Wolf says. "Direct firms have added managed account programs and have been promoting them for clients who desire ongoing advice. In short, direct firms are getting better at identifying, targeting, and retaining advice-seeking clients.”

 

 

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