A poor understanding of basic financial concepts makes retail investors vulnerable to mistakes and financial fraud, according to the SEC. Who’s most at risk?
American investors fail to understand the “most elementary” financial concepts, such as compound interest, inflation, diversification or the difference between stocks and bonds, according to a recent report from the U.S. Securities and Exchange Commission, which finds that the problem is more acute among women, African-Americans, Hispanics, the oldest Americans and those with low levels of education.
These low levels of financial literacy threaten the retirement security of “broad segments” of the U.S. population, according to the SEC report, mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Among other things, retail investors are not fully aware of investment costs and their impact on investment returns, and lack “critical knowledge” about investment fraud. The knowledge deficit makes it difficult for investors to evaluate financial professionals and select investment products, according to the SEC, which contracted the Library of Congress to survey studies conducted since 2006 on financial literacy among retail investors.
Financial knowledge is highly valued by Millionaire investors, who attribute their success primarily to hard work, education, smart investing and frugality, according to ongoing Millionaire Corner research. The richer investors are, the more likely they are to describe themselves as knowledgeable about financial products and investments. More than 60 percent of investors with a net worth of more than $125 million say they are “very knowledgeable, while 32 percent say they are “fairly knowledgeable,” according to our newly released $25 Million Plus Investor 2012 study.
Our research also suggests that financial professionals can play an important role in helping investors increase their financial literacy. Financial advisors rank as the most important source of investment information among $25 million plus investors.
Retail investors indicate a desire for clear, transparent information about the forms of compensation and investment strategy of a financial advisor, as well as any potential conflicts of interest or disciplinary history, according to the SEC. Investors also want to know the identity and scope of services of an advisor’s firm.
When selecting investments, retail investors prefer summary documents containing key points about the product. They seek information about the fees or expenses, and risks associated with a product, as well as the past performance and investment objective of the product, according to the SEC. Investors favor clear, concise documents that contain understandable language, bullet points, tables, charts and graphs.