Financial illiteracy is a big problem in America, and it has huge ramifications for financial advisors. An SEC study published in 2012 found that “U.S. retail investors lack basic financial literacy,” “have a weak grasp of elementary financial concepts” and “lack critical knowledge.”
A 2015 study of financial literacy that covered adults in 148 different countries found that we rank 14th, just behind Singapore and the Czech Republic and slightly ahead of Estonia and Bhutan. Only 57% of the Americans surveyed could pass a basic financial literacy test.
The situation does not seem to be improving. A comparison of two Finra surveys done in 2009 and 2012 showed a decline in financial literacy over that four-year period. The president of Finra’s Investor Education Foundation summed it up: “Directionally, it was discouraging.”
On the bright side, Americans are aware of their shortcomings. In a 2015 Harris Interactive survey, 41% of the participants graded their personal financial knowledge as “C,” “D” or “F.”
The Nature Of The Problem
There are three parts to this problem. The first is a lack of formal education. Historically, there has been very little attention given to financial education in this country. My generation has passed their financial ignorance down to their children. Even today, only 17 states require any form of personal financial education in high school, and it seems to have had little impact.
A 2012 study of financial literacy among teenagers from around the world placed Americans in the middle of the pack, just behind Polish and Latvian teenagers. One in six failed to reach baseline proficiency. Not a good showing for the kids from the richest country in the world.
Another part of the problem is that becoming financially literate requires mastering a range of technical information that is boring, uninteresting and inaccessible to most people. Our industry has done nothing to solve this problem and, in fact, has made the problem even worse. Our use of jargon and our love affair with complexity has made the topic even more impenetrable. We don’t seem to want people to understand what we do—we like the mystery.
The third and most difficult part of the problem is that we are not wired to be good savers and investors. Researchers in the area of behavioral finance have documented this problem, but haven’t done much to recommend solutions. This is the most interesting part of the puzzle.
It’s A Problem For Everyone
Financial illiteracy is both a major societal problem and a very practical problem for financial advisors. If people don’t learn how to save and invest properly, they won’t have sufficient resources to retire. This is a big issue as our life expectancies have grown over time. People may choose to keep working for a while, but eventually they will become too old or too sick to work. Then they become a problem that we have to deal with collectively as a nation.
On a more practical level, financial illiteracy is a big problem for financial advisors, whether they recognize it or not. If you ask advisors what their three biggest challenges are, almost every one of them will tell you that “getting my clients to do the right thing” is a major issue.
Clients simply don’t have a good frame of reference for dealing with financial matters. They don’t understand investments, markets or know how to interpret events they experience as investors. Under stress, they are skittish and unpredictable like a deer in the headlights. If they knew more about how to behave as successful investors, this problem would be reduced.
Here’s a common scenario for financial advisors: when they have a client who needs to take more risk in order to reach financial goals, but has a very low tolerance for it. Should the advisor build a riskier portfolio knowing that the clients may not be able to handle it, or dial down the risk knowing the clients have a greatly reduced chance of reaching their goals?
Solving The Problem
Financial education can help close the gap. Clients who understand more about investing, markets and how to behave in order to maximize success can make better decisions. If they understand the situation and what they need to do about it, they can handle more risk.
The problem cannot be solved simply by making more information available to clients. There is no shortage of information about investing and personal financial management. The problem is that most of the information is useless to the people who need it.
Most of it falls into one of three categories. It may take the form of academic papers or peer-reviewed articles, which are far too technical for most people. It may be sales literature masquerading as advice. Or it may be the talking-head type of offering, which is generally worthless and usually designed more to entertain than to educate.
To be effective, the information has to be properly targeted to the needs, habits and aptitudes of the audience. Financial information competes with all the other information in the world that is vying for the attention of that audience. So it must be clear and concise. It must be accessible and digestible. It must be credible. If possible, it should be fun and interesting.
But even properly crafted and targeted information cannot entirely solve the problem. That’s because part of the problem is behavioral, not informational. Delivering well-crafted information helps, but you also have to help people change their behavior. That means you have to deliver a different type of information.
People need help stepping outside of themselves and recognizing the tendencies that get them into trouble. The list is very long and has been well-documented by academia and the popular press. But teaching people the long list of behavioral quirks is not the answer. They don’t need a degree in behavioral finance. They need a simple set of rules they can follow to improve their behavior. They don’t need to understand the disease. They need to stop the symptoms.
Advisors As Educators
This is a tremendous challenge, but it’s entirely possible. You can teach soldiers to perform effectively on a battlefield. You can teach athletes to keep their cool in the midst of chaos. You can teach people to overcome all manner of fears, addictions and bad behaviors. There’s no reason it can’t be done in the area of investing and personal finance.
Financial advisors need to be on the front line of this effort. Traditionally, advisors have seen themselves as portfolio managers or financial planners, not as educators. But portfolio management and financial planning only address part of the client’s problem. People need to know how to behave so their portfolios and financial plans have a chance to produce the results they were designed for. They don’t have to learn to be great investors themselves, but they need to have a grasp of what is going on around them. Advisors must teach them.