SEC’s Financial Literacy Study Reveals Significant Financial Illiteracy of Investors

Posted on September 5th, 2012 at 9:59 AM

The Dodd-Frank Act (more formally known as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010) requires the SEC (Securities and Exchange Commission) to conduct a study to identify the existing level of financial literacy among retail investors as well as to identify methods and efforts to increase the financial literacy of investors.  At long last, the study has arrived. 

In over 200 pages, the SEC conducts an analysis, makes findings and reaches conclusions.  The SEC relied on a number of different resources in order to complete the study.  Those resources included contracting with the Library of Congress, seeking public comments, conducting focus groups and online surveys, and engaging an outside consultant, but states that it “has expressed no views regarding the analysis, findings or conclusions.”  Let’s review the study.

                First, the SEC cites studies reviewed by the Library of Congress, which indicate that “U.S. retail investors lack basic financial literacy.”  Those studies, according to the SEC, demonstrate that investors have a “weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.”  The SEC also cites surveys that “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.”

                Second, the SEC identifies several methods to improve the timing, content and format of disclosures related to investments, the selection of a “financial intermediary” and the transparency of expenses and conflicts of interest.  For example, investors prefer disclosures in advance of making a decision.  Likewise, investors prefer investment product disclosures to contain “summary key information”, with more detailed information available.  The format of the disclosures received mixed responses as to hard copy versus online disclosure, but otherwise the consensus was that disclosures should be clear, concise, understandable, using bullet points, tables, charts and/or graphs.

                Third, the SEC found that investors want to know the following information before hiring a financial intermediary: fees, expenses and compensation; investment performance and track record; investment strategy; disciplinary history; scope of services; and sources and amount of compensation.  Similarly, with regard to purchasing an investment product, the SEC found that investors want to know the following information: fees and expenses; investment performance; principal risks; and investment objective.

                Fourth, the SEC reviewed methods to increase the transparency of expenses as well as the transparency of conflicts of interest with respect to investment services or products.  Possible methods with respect to transparency of expenses include: providing a narrative explanation and a fee table; simplifying the wording; placing total compensation information on trade confirmations; and at the point of sale, requiring an explanation of how the financial intermediary will be paid.  Regarding transparency of conflicts of interest, possible methods include: providing specific examples that demonstrate how a conflict of interest would operate in relation to the specific advice furnished; and using a bullet point format to present the conflicts of interest disclosure and making it more specific (or at least have additional disclosure available).  The most effective method proposed, however, was the following: “Disclose whether a financial intermediary (the individual representative) stands to profit if a client invests in certain types of products; whether the financial intermediary would earn more for selling certain specific products instead of other comparable products; and whether the financial intermediary might benefit from selling financial products issued by an affiliated company.”

                Fifth and finally, the SEC study identifies the most effective ways to increase the financial literacy of investors.  The SEC sets forth a strategy to develop programs: 1) targeting specific groups including young investors, lump sum payout recipients, investment trustees, the military, underserved populations and the elderly; 2) promoting the importance of checking the background of investment professionals; 3) promoting websites such as as a primary resource; and 4) promoting awareness of fees and costs of investing.

                As one can see, the SEC is taking a step in the right direction.  Given the politically charged environment, it is no wonder that the SEC “has expressed no views regarding the analysis, findings or conclusions.”  But through the study the SEC has provided a road map for industry, state regulators and the self-regulatory organizations to begin improving the financial literacy of investors.  That’s good news!


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