The results of a recent survey reveal that most Americans, including retirement plan participants, failed a fluency quiz of key investment selection terms, which can translate into saving less and lower use of investment products.
Hearts & Wallets’ “Financial Fluency: What Consumer Understanding of the Language of Finance Means for Advice, Retirement and Asset Management” finds that only 19% of Americans achieved a passing grade when asked to choose the best answer for seven key investment selection terms that were presented to participants in a national survey of nearly 6,000 U.S. households.
The terms were divided into four basic investment selection terms and three more advanced terms; a passing grade was when respondents selected the best answer for five or more terms. Questions on basic investment selection terms included what’s the best definition of mutual fund, asset allocation, exchange traded fund and cost basis, while questions on advanced terms included the best definition of passive investing, differences between Roth and traditional retirement accounts, and taxable brokerage accounts.
Deterred Participation
Based on the findings, a lack of financial literacy may deter eligible participants from plan participation, Hearts & Wallets further observes. One in three potential participants in workplace retirement plans did not know any definitions for the four basic investment selection terms fundamental to their ability to select investments within plan. In addition, more Americans who are eligible but not participating do not know the best definition for any of the terms versus participants (38% vs. 29%). Amazingly, only 14% of current plan participants correctly answered all four of the questions on basic investment terms.
“Many surveys assess consumer financial literacy,” says Laura Varas, CEO and founder of Hearts & Wallets. “Our goal was to extend the conversation into investing. Lack of understanding of the words that plan participants need to make decisions has implications for our national retirement system and improving plan design.”
Not surprisingly, fluency is much higher for consumers with higher education levels. Being a consumer of advice also helps, the report notes. Consumers who use paid investment professionals as their “go-to/primary” or usual sources of investing information and advice are more likely to know the best definitions for five or more terms.
Conversely, only 28% of consumers who use workplace resources as their “go-to/primary” source of investing information and advice know three-plus terms. And 3 in 10 consumers who identify as self-directed investors did not know the best definition for even one term.
The survey also found that Millennials and women are among the groups that need the most help in understanding basic concepts fundamental to their ability to select investments within a plan.
Language Barriers
Meanwhile, consumer confusion with language can correlate with negative household financial impacts, the report further emphasizes. For the term “passive investing,” slightly more than half (51%) of all consumers selected “don’t know” rather than one of the two definitions.
Adding to the confusion, Hearts & Wallets found that, among consumers who chose a definition, more consumers selected the definition that differs from the one touted by large financial services firms. Nearly one third (29%) of consumers picked “buying and holding without being influenced by short term market fluctuations” while 20% selected “investing in an index, often weighted to market capitalization.”
Moreover, consumers who “don’t know” the definition of “passive investing” were found to save less and use fewer investment products. They are less likely to own mutual funds, lack exposure to the stock market and are less likely to allocate any savings to IRAs. What’s more, they have high cash allocations with 44% having 90% to 100% of assets devoted to cash versus 26% of “buy and hold” and 15% of “index” allocations.
The language barrier is most acute among plan participants with less than $100,000 in total assets. Only one in four (27%) participants with less than $100,000 in total investable assets (not just in plan) knew the best definition for three or more basic investment selection terms, and 34% did not know even one.
“Where complex choices require technical language for explanation, firms may want to consider introducing new, more intuitive concepts to help consumers become more confident about investing,” says Beth Krettecos, Hearts & Wallets Subject Matter Expert. “Advice also plays a role in helping consumers succeed in saving and investing.”
The report draws from Hearts & Wallets’ latest IQ Database survey wave, which was fielded in August 2020 and includes 5,920 U.S. households.
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