How Financially Sophisticated is America’s Older Population?

retirement plan and reading glasses

As people grow older, they start paying more attention to their retirement.

But evidence suggests that much of the United States’ older population is ill equipped to take responsibility for their retirement security – because their financial sophistication falls short of where it needs to be to make the complex financial decisions retirement requires.

A paper, authored by Annamaria Lusardi, Olivia S. Mitchell, and Vilsa Curto and published in the Journal of Pension Economics and Finance, takes a closer look at the financial sophistication of older Americans.

From the paper:

In 2008, we subjected around 1,000 randomly-selected HRS respondents in the United States to a special module of questions assessing knowledge of the stock market and asset prices, investment strategies, risk diversification, the importance of fees, and related topics. Respondents averaged age 67, with about half (55%) female. Some 15% had less than a high school education, 32% had completed high school, 24% had some college, and 28% had college or advanced degrees. Most (81%) of the respondents were White, with 9% African-American, and 8% Hispanic.


The 10 questions of key interest here are grouped into four categories, according to the topic they cover: knowledge of capital markets, risk diversification, knowledge of fees, and savvy/numeracy.

The results:

Older Americans displayed a deep lack of understanding about key concepts related to risk diversification, bond prices, and portfolio choice. For instance, many respondents expressed a support for holding own employer company stock, despite the fact that it is unlikely to be wise to hold much own employer stock from a risk diversification viewpoint…

A large majority of respondents (60%) also did not know about asset pricing, which we explore by asking whether people knew about the inverse relationship between bond prices and interest rates. This is a particularly good question to assess financial sophistication because it is difficult (if not impossible) to know or infer the correct answer to this question without having some knowledge of finance.


When presented with the statement ‘If the interest rate falls, bond prices will fall’ (second wording), only about one-third (35.7%) of respondents answered correctly; when the wording was reversed (first wording: ‘If the interest rate falls, bond prices will rise’), more answer correctly (44.7%) and this difference is statistically significant.


Many respondents were aware that ‘Even if one is smart, it is very difficult to pick individual stocks that will have better than average returns.’ But here, too, responses varied depending on how the question was asked: in one case 73.7% got the correct answer, but only 37.6% got it correct using the reverse ordering. In other words, this question, too, was poorly understood by respondents.

The authors also posed questions about risk diversification and fees:

Almost two-thirds of respondents knew that ‘it is not a good idea to invest in a few stocks rather than in many stocks or in mutual funds,’ which might be thought to imply some sophistication about risk. Yet this question jointly tests knowledge of risk diversification and awareness of mutual funds, as indicated by results when we reversed the question wording: responses proved quite sensitive. The second risk question sought to avoid this by simplifying the question and using less financial terminology; and now we find that most knew that spreading money across 20 stocks rather than two decreased the risk of losing money (and here, word order did not matter).


Several prior studies have found that investors often overlook fees when deciding how to invest…In our sample of older Americans, around two-thirds seemed to know that mutual fund fees are important when investing for the long run. Nonetheless, responses were again sensitive to question wording, perhaps due to the fact that respondents needed to know both about mutual funds and investing for the long run. Additionally, a large majority of respondents said they would find it difficult to locate mutual funds charging annual fees of less than one percent of assets, suggesting that many respondents may not know about low-cost mutual funds. The fact that again there is some sensitivity to question wording confirms that, here too, respondents have difficulty with financial terminology (fees, mutual funds, etc.).

The paper, titled Financial literacy and financial sophistication in the older population, features much more analysis and discussion of the survey data, and can be read in full here.

Supreme Court To Hear Case on Excessive 401(k) Fees

Supreme Court

Mutual fund fees will soon have their day in the highest court in the land.

The U.S. Supreme Court has agreed to hear a case centered on “excessive” fees collected by mutual funds in 401(k) plans. The case will also determine whether there should be a statute of limitations on lawsuits alleging fiduciary breach. From Investment News:

As a landmark 401(k) excessive fees lawsuit makes its way to the U.S. Supreme Court, industry experts say the court’s decision could set off a domino effect of changes — from the process of choosing plan funds to fiduciaries’ ability to obtain liability insurance.

The case in question is the famed Glenn Tibble v. Edison International, a suit originally filed in August 2007 in the U.S. District Court for the Central District of California. The original suit centers on six retail mutual funds in Edison’s plan menu, which were offered instead of cheaper institutional share classes.

Though the plaintiffs eventually received a 2010 judgment from the district court, they were granted only $370,732 in damages related to excessive fees in three of the mutual funds. The saga continued as both parties battled over fees, bringing the suit to the 9th Circuit Court of Appeals. Last week, the Supreme Court agreed to review the case.

Currently, the defendants are arguing a statute of limitations requires that plaintiffs bring a suit alleging fiduciary breach within six years of the last action constituting the breach.

The ruling will have big implications for retirement plans and the people that run them. From Investment News:

Though some ERISA attorneys interpreted the focus on the six-year statute of limitations as a litigation tactic, other retirement industry experts noted that where the court lands on that issue could shape how fiduciaries serve retirement plans and participants.

“The theory of open-ended liability that could be continuing: On the one hand, you might be more protective of participants, but on the other hand, it can limit the degree to which [liability] insurance is written,” said Jason C. Roberts, CEO of the Pension Resource Institute, a retirement plan consulting firm for broker-dealers.

Aside from the statute-of-limitations issue, the retirement industry will likely be shaken to its core given the fact that the highest court in the land is going to address the issue of excessive fees in 401(k)s. Greater attention to fees by the powers that be could tip the scales even more in favor of cheaper retirement plan offerings.

“It depends on what the Supreme Court is going to do: Will they answer the questions of whether there’s a bright line with institutional versus retail funds,” said Marcia Wagner, a managing director of The Wagner Law Group. “If the Supreme Court says something that clearly, I think the entire industry will move in that direction.”

“I think you’ll see the larger plans, and even the small to midsized plans, going institutional,” Ms. Wagner said. “The salient issue for the Tibble case is that the same funds were available in both institutional and retail. What’s the difference that justifies the fees?”

Read more on the case here.


Photo by  Mark Fischer via Flickr CC License