Well, it's official: Most Americans don't know squat about financial investing.
That's one of the chief conclusions of a 212-page study of financial literacy that the SEC, collaborating with the Library of Congress, released late last month:
. . . American investors lack basic financial literacy. For example, studies have found that investors do not understand the most elementary financial concepts, such as compound interest and inflation. Studies have also found that many investors do not understand other key financial concepts, such as diversification or the differences between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns. Moreover, based on studies cited in the Library of Congress Report, investors lack critical knowledge about investment fraud. In addition, surveys demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population.
Surprised? Of course, you aren't. This finding is hardly new and -- as the study notes -- simply reports on previous surveys which show stunning public ignorance of the stock market, investing, and retirement planning. As Demos itself reported earlier this year, for example, a majority of 401(k) holders don't even know that their plans charge fees -- much less how those fees cut deeply into their nest eggs over time.
In fact, though, things are even worse than many of us who do track this stuff realize. It's one thing not to know that 401(k) plans charge fees. But, wow, the fact that many Americans can't grasp the concept of compound interest or the difference between stocks and bonds indicates a far more troubling level of public ignorance.
In an example of typical bureaucratic understatement, the Library of Congress concludes that “low levels of investor literacy have serious implications for the ability of broad segments of the population to retire comfortably, particularly in an age dominated by defined-contribution retirement plans.”
Translation: Americans can't be trusted with their own money -- at least not when it comes to setting aside enough to retire on.
I don't say this in a patronizing way. Judging by returns on my own 401(k), which I do pay attention to and understand, I don't particuarly trust myself with my money.
The SEC's findings have two implications for today's broad debate over government's role in the economy.
First, it shows the naivete of a central premise of laissez-faire ideology, which is that the market can "police itself" because informed consumers will punish exploitative or rogue businesses. Obviously if you don't know anything, it's hard to punish anyone. As Demos' 401(k) study revealed, employees (and also their employers) rarely respond to excessive fees by engaging in the most elementary market activity of comparison shopping -- which means that investment firms can charge excessive fees without consequence. And, mind you, we're not talking about buying a refrigerator here; we're talking about securing one's retirement. Low returns thanks to bad investmetn choices aren't the only problem. Investor ignorance also explains why Ponzi schemes and other financial frauds are so common. Americans are sitting ducks for bottom feeders gunning for their money.
Second, the stark truth about financial illiteracy shows the limits to individual empowerment and choice. Conservatives say, again and again, that government needs to step back and let individuals take greater charge of their lives. But many of us feel overloaded by all our choices as it is. It's hard enough choosing a cell phone plan for many people, much less figuring out whether to go with large cap or small cap funds. We don't all want more choices, especially when the stakes are so high. We want professionals to figure things out for us. That's one reason why Demos supports scrapping the current 401(k) system in favor of a universal system of individual accounts that would supplement Social Security and where investments would be managed in pooled accounts by professional investors.
It's not paternalistic to say that Americans -- as investors, consumers, or employees -- don't have perfect information and that they can't manage, and often don't want, endless choices. It's simply a statement of fact. And the SEC study is yet more evidence in support of that fact.