Studies have found that an advisor can only help so much. The client's own financial knowledge has a large impact on financial perform.
If you are a regular reader, then you are likely to make more money when you invest. This is because you are a sophisticated investor and can tolerate what some would consider monotonous information. (I said it—kindly, you didn’t.)
This is the scoop. Robert Clark of North Carolina State, Annamaria Lusardi of George Washington University, and Olivia Mitchell of the Wharton School found a correlation between investment success and scoring high on financial knowledge. Their working paper entitled, “Financial Knowledge and 401(K) Investment Performance,” is available on the National Bureau of Economic Research.
What makes their study unique is that they examined defined contribution (DC) plans. That is, a plan in which the employer, employee, or both make retirement contributions on a regular basis. The researchers looked at the DC performance of 22,000 US workers and correlated it with their financial knowledge.
The institution from which the data was gleaned was not identified for the sake of confidentiality. Ten years of performance data was assessed. A 5-question online quiz was used to determine financial knowledge and, as it turns out, only 16% of the participants took the quiz or, by my math, 3,520 of the 22,000.
Clark, Lusardi, and Mitchell found that those who were most financially sophisticated earned 130 basis points or 1.3% more than those who were less so.
This result plays into what we already know about financial literacy and performance.
An advisor can only do so much. The client’s financial sophistication makes a difference, too.
In 2011, Calcagno and Monticone found “non-independent advisors are not sufficient to alleviate the problem of low financial literacy.” Their working paper, “Financial Literacy and the Demand for Financial Advice,” can be found on the Social Science Research Network.
In 2012, Michael Collins replicated this idea when he wrote “financial advice is a complement to, rather than a substitute for financial knowledge.” His accepted paper entitled, “Financial Advice: A Substitute for Financial Literacy?” is on the same website.
Just this year, Clark and colleagues found a shocking 62% of Americans do not make investment decisions based on knowledge, but rather advice from family and relatives. Their article “Can Simple Informational Nudges Increase Employee Participation in a 401(k) Plan?” was published in The Southern Economics Journal.
The take away from all of this material is that those who are financially sophisticated make more money in the stock market compared to the general population. They also take more risk, according to the DC study, possibly because these individuals have more money due to their knowledge and, therefore, can afford to take more risk. Additionally, their inherent genetics compounded by experience may contribute.
An interesting part of the DC study is that there were few pension options offered and most were index funds, known to provide higher returns in large part due to low fees. If the financial choices were greater and the offerings more complex with higher inherent charges, then the results would be expected to skew even more toward the sophisticated investor, who could navigate within the complexities.
It is my opinion that this study by Clark, Lusardi and Mitchell provides important information. Though it is still in review, the main thrust will almost certainly remain the same. Financial knowledge gives an edge. Though it can be tedious to delve into, there are few areas where the reward is so great.
This information and content is offered for informative and educational purposes only. MyMoneyMD, LLC, is not acting as a Registered Investment Advisor, Investment Counsel, Tax Advisor or Legal Advisor.