Investors don't know what they don't know

Here’s a reality check about financial literacy. American Century conducted a short 10-question survey of 680 Americans between the ages of 18 and 41 and found that less than half understood the fundamentals of a well-diversified portfolio. I found this shocking result the Chicago Tribune on Sunday May 27 (as well as some other publications): Less than 20% could recognize the definition of asset allocation.

The survey posed the following question: "Which of the following is true about asset allocation?"

• Asset allocation is a strategy where investments are divided among different asset classes such as stocks, bonds and cash.
• According to academic studies, a portfolio's investment returns over time are based mostly on its asset allocation.
• Asset allocation lowers a portfolio's risk because losses in one type of investment are offset by gains in others.
• All of the above.
• Don't know.
  

Only 14% of Younger Adults (age 18 to 26) picked the correct answer -- "all of the above." Generation Xers (age 27 to 41) faired only slightly better as 18% responded correctly. To their credit, 60% of the Younger Adults and 49% of Generation Xers chose "don't know," suggesting they are more inclined to admit ignorance (but also to learn) than to try to guess.

What this tells me is that financial literacy is not where it ought to be. Financial advisors tend to assume concepts like asset allocation and diversification are common knowledge. And, as an industry, we tend to focus on more sophisticated matters like Modern Portfolio Theory and products like hedge funds. But after years of financial education, the market needs are much more basic.

Words to the young and wise

Emily Meehan of the Wall Street Journal spells out "What to Do with $2,500" — a column that gives younger investors clear plans of action from financial wizards, most of whom normally advise only millionaires:

I spoke with five financial advisers about what a young investor should do with a small windfall: $2,500. I created a profile of a twentysomething novice investor who doesn't have debts and is diligently paying into a 401(k). Investor X doesn't necessarily want to lock up this money until retirement. He or she may want to buy a house, fund a year off or have something socked away in case of a car crash or other emergency.

The advice comes from five different managers, including independent financial planners as well as consultants from the likes of Schwab and T. Rowe Price. They come up with five quite different plans of action:

1. Set up a Roth IRA
2. Put some money aside in a CD
3. Be aggressive
4. ETFs!
5. Take the bond route

I don't want to critique the individual strategies. What's nice about the slant of the article is that it proposes several real-world, proactive plans that are actually achievable by a 25-year-old. It focuses on what can be done, and why. People, especially younger people with the need but without the access to the holistic advice of a wealth manager, could benefit from guidance that says, as specifically as possible, "do this."

How big is the demand for such proactive plans of action? You decide. Emily's column is #1 in the "Most Popular" links at today's WSJ.

Go to a Mid-Sized Pension Conference

The best way for a benefits manager, HR professional, plan provider, or plan sponsor to keep a finger on the pulse of what’s happening in the World of Pensions and Retirement Plans is to attend a Mid-Sized Pension Management Conference. Four regional conferences are held each year, usually Orlando in January, San Francisco in March, Boston in May, and Chicago in October. As someone who has spent 15 years attending industry conferences, in my opinion, these conferences are the best. My reason is simple. There are first and foremost educational conferences. Unlike many conferences where all the speakers, workshops, and breakouts are trying to sell you something, the Mid-Sized Pension Conferences is careful to omit hard or soft sales pitches. As a fiduciary, administrator or manager of your Company’s Plan, you need to attend one of these conferences each year.

A Retirement Reality Check for PPA

On its surface, PPA's safe harbor automatic enrollment provisions seem to simultaneously solve two common problems: low participation for plan sponsors and low savings rates by participants. However, a recent study by Plan Sponsor magazine revealed that plans with automatic enrollment achieved 80% participation compared to 75% for plans without automatic enrollment. This is a long way from the 90% to 95% that experts anticipated.

At the core is the reality that plans tend to apply automatic enrollment prospectively. PPA does not require employers to apply automative enrollment retroactivley so it is likely plans will continue apply the provision on a prospective basis. As a result, new employees will participate and begin saving for their futures. Existing employees, will continue to sit on the sidelines.

What is needed to changed employees from passive participants and non-participants to active retirement planners? Education! Increased financial literacy will help engage participants encouraging them to take charge of their financial futures.

Retirement Income: The Final Frontier

With over $16 trillion at stake, there's little doubt that the next great tidal wave of personal financial activity will consist of retirement income for the baby boomers.

What is still hazy is how exactly financial advisors and financial products will serve that activity. Writing for MutualFundWire.com, Sean Hanna reports from last week's ICI conference by offering an assessment of how the mutual fund industry might prevent itself from being left out in the cold...

No one knows how the nascent retirement income industry will play out, no one knows what kind of products will be gain wide appeal and no one knows the role of mutual funds in generating retirement income. [...]

The MassMutual product entry allows investors to allocate their portfolio between an immediate annuity and mutual funds. They are even allowed to reallocate assets back to the funds. Johnson says that while the product only offers mutual funds from MassMutual affiliate OppenheimerFunds today, he expects that a open-platform version of the product will debut down the road.

If retirement income does take off, products like the MassMutual one may be one of the few ways mutual funds can hang on to their assets. As [senior vice president] Tom Johnson explains, products like MassMutual's may be one way for mutual funds to hang on to their customers, and those customers' assets.

Fascinating stuff — and a wake-up call too.

Retirement & Healthcare: Convergence or Disturbance for Financial Advisors

In today’s Wall Street Journal, (5/14) a short article on page C6 entitled Advisers To See Their Roles Shift crystallized a point that has been bothering me for some time. Whose job is it to take care of our future? Should we embrace our independence and become financial and healthcare experts, equally comfortable with Wealth Accumulation and Asset Allocation as well as Managed Care, Wellness and Disease Management?

As someone who has championed financial literacy for two decades, it becomes increasingly apparent that most people will not do it for themselves and will need “professional help”. In the retirement business, we have learned to use people’s inertia against them by introducing auto-enrollment and auto-deferral increase programs. Once enrolled in these plans many people will not make the effort to opt out and ultimately, that behavior may help create some retirement benefits down the road. Must we do the same for healthcare?

And, where will the champions of this effort come from? Will there be a new hybrid financial/healthcare advisor who will take a holistic approach to an individual’s needs? Who will be the first to step up to the plate and redefine the industry? Surely the answers begin with those far-sighted individuals and organizations like the Investment Company Institute who have a platform to begin the discussion. Plaudits to the ICI – now who else wants a turn at bat?

Shocking Statistic

Here's a shocking statistic from Robert Powell at Retirement Weekly:

Of the 77 million baby boomers planning to retire in the next 10 to 15 years, 75% are hurtling toward unexpected financial difficulties, including having to go back to work. Unfortunately, many people won't realize how ill-prepared they are for retirement until it's too late.

Wish I'd said that, vol. 1.

It isn't often a portfolio manager says something that not only can be understood but is actually useful to an ordinary human being.

Yet here is David Williams, who helms the Excelsior Value & Restructuring fund, making complete sense of it all for you and me:

Williams: I caution people who are getting into investing not to listen to all that stuff on CNBC.

Interviewer: So you don't leave the monitor on during the day?

Williams: Oh, no. I don't even have one in my office. The problem with CNBC is that they throw so much at you, and you have to somehow put it all together and make sense out of it. Look, this isn't that hard. Don't play the momentum game; buy for the long term.

Words of wisdom to invest by!

Quoted in the March 2007 edition of Kiplinger's Personal Finance, not yet online.

Early Retirement

A writer for Dow Jones shares her story about retiring early. From the article it appears that the writer had done the math before entering semi-retirement -- underscoring the fact that we can all be caught off guard. While this story has a happy ending, not all of them do.

In the '90's, early retirement was widespread. A number of factors including market conditions and lack of planning has forced many of unfortunate retirees back to work. Today, instead of early retirement, the trend is toward changing careers -- for example moving from the board room to the classroom. By continuing to work, even at a reduced salary, people can extend the life of their nest eggs while feeling good about what they're doing.