Washington has an investor crisis that needs attention. The financial literacy of Americans is at a dangerously low level, at a time when more people have become responsible for their own retirement savings and as the future of government subsistence programs have fallen into question.
A recent government study shows that most citizens don’t know much about how the economy works, they don’t know basic investment concepts such as the difference between stocks and bonds, and they lack rudimentary knowledge about risk, return, and investment planning.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 tasked the Securities and Exchange Commission (SEC) to gauge the level of financial literacy that exists in America among individual investors. The SEC’s goal was to assess general financial knowledge and determine specific knowledge of investment fraud, fees, and risk. The research also evaluated this knowledge based on subgroups defined by age, gender, and race.
The SEC’s published report was sobering. Here is an excerpt from the conclusion:
“Quantitative studies conducted from 2006 to the present on the financial literacy of U.S. retail investors conclude overwhelmingly that American investors lack essential knowledge of the most rudimentary financial concepts: inflation, bond prices, interest rates, mortgages, and risk. Consequently, it is not surprising that investors do not understand advanced financial concepts such as differences between stocks and bonds, the role of the stock market, and the value of portfolio diversification.”
Low levels of investor literacy have serious implications for America. We live in an age dominated by defined-contribution retirement plans, where workers make their own investment choices. A lack of basic knowledge will seriously erode individual investment performance in the future and that threatens broad segments of the population who wish to retire comfortably.
Something must be done to increase basic investor awareness, and this effort must come from Washington − because it won’t come from Wall Street. An intense effort to prudently educate investors is essential to the general financial health of Americans and of America.
This help will not come from the for-profit investment industry because product sales are the main driver behind the advice investors receive. Even new ideas that were originally designed to reduce cost and increase return have degenerated into high cost speculative products designed to increase the amount of money the industry takes in.
The exchange-traded fund (ETF) market is a prime example of a good product that has been high-jacked by Wall Street. ETFs were originally created as low-cost index funds designed to generate the return of a market. They gave all investors access to a broad basket of securities and could be used to build affordable portfolios. While many ETFs still provide this benefit, the ETF landscape in general has been heavily polluted in recent years. Many new funds that have launched in the past 10 years are high-cost products that are designed for speculation and to be used as part of a trading strategy.
Wall Street will always figure out a way to turn a product that’s good for investors into a high-fee money machine that aids the industry. I wrote an article about this titled, Thrown Under a Bus With Model ETF Portfolios. Jason Zweig also investigated this issue in a recent Wall Street Journal article titled, When Cheap Funds Cost Too Much.
So, what’s the answer?
Ironically, the federal government’s own Thrift Savings Plan (TSP) doesn’t fall prey to the problems facing the rest of the investing nation. It provides government employees and active duty military an excellent low-fee program. There are no expensive actively-managed funds in TSP, and no fees are paid to advisers for speculating on markets. Most of the investments in the program are index funds, each of which is invested in order to replicate the risk and return characteristics of a particular market.
Washington has already figured out that low-fee index investing is in the best interest of its employees and the military. So, why not take it one step further to help solve the financial literacy in America by giving TSP to the rest of that nation? Require employers who offer a 401(k) or similar employee savings program, to use TSP − or at least use low-cost index funds modeled after it.
Some people will say that mandating employers to adopt the government’s TSP program is too much intrusion. Undoubtedly, the protest will come mainly from financial firms and advisers who have the most to lose. As a compromise, Congress could make the program optional, but give employers who adopt the principles safe harbor from employee lawsuits involving plan investment options.
The financial literacy of Americans is at a dangerously low level and this will create problems for our nation unless something is done. Washington should become more involved. Government already drives K-12 education and is deeply involved in higher education, and tools such as TSP are all ready in place to improve the system on a mass scale. It’s time for Washington to step up and act.