U.S. retail investors possess a weak grasp of basic financial concepts and generally lack the knowledge necessary to avoid getting ripped off, according to a recent report from the Securities and Exchange Commission (SEC). The report was mandated by Section 917 of the Dodd-Frank Act and discusses the hallmarks of effective investor education programs and methods to improve disclosures.
Dodd-Frank required the SEC to study several topics related to investor protections, including: the existing level of financial literacy among retail investors; methods to improve the disclosures provided to investors in various circumstances; and a strategy to increase the financial literacy of investors in order to bring about a positive change in behavior.
The SEC based its findings related to investor literacy on a series of studies reviewed by the Library of Congress.
“The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud,” the SEC said. “Surveys also 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.”
The paper also set forth a plan to improve investor literacy based on comments the agency received from the public and discussions between the SEC’s Office of Investor Education and Advocacy (OIEA) and the Financial Literacy Education Commission (FLEC), an interagency panel tasked with developing a national strategy on financial education.
FLEC participants said the content of a program to improve investor literacy should focus on four areas including: different types of risk; the fees and costs associated with investing; proactive steps for avoiding fraud; and general investment knowledge, including topics such as compound interest.
“FLEC participants also agreed that these content areas should be highlighted in financial education and capability efforts generally, especially at schools, in the workplace, within communities and by families,” the report noted.
FLEC participants promised to work together to develop joint investor education programs that target specific groups including young investors, members of the military, underserved investors and older investors. The panel also agreed to work on an “ask and check” campaign that would encourage individuals to check the background of investment professionals before investing with them and another campaign to help investors understand the fees and costs associated with buying, owning and selling investments.
Disclosures
Much of the report focused on investor disclosures, including methods to improve the timing, content and format of disclosures to investors with respect to financial intermediaries, investment products and investment services. According to SEC research, investors prefer to receive disclosures before making a decision on whether to engage a financial intermediary or purchase an investment product or service.
“With respect to financial intermediaries, investors consider information about fees, disciplinary history, investment strategy and conflicts of interest to be absolutely essential,” the report noted. “With respect to investment product disclosures, investors favor summary documents containing key information about the investment product.
To increase the transparency of expenses associated with investment products and services, the report suggested that disclosers could provide both a narrative explanation of fees and compensation and a fee table. The report also set forth suggestions for helping clients recognize possible conflicts of interest in transactions. For instance, the agency said disclosures could provide examples of how a potential conflict of interest could arise in relation to specific advice provided to an investor. Disclosures could also include information on whether a financial intermediary stands to profit if a client invests in certain types of products.