The Financial Industry Regulatory Authority, commonly referred to as "FINRA," is a private organization authorized to regulate all U.S. broker-dealers.
In 2003, FINRA established the FINRA Investor Education Foundation with a mission to "empower underserved Americans with the knowledge, skills and tools to make sound financial decisions throughout life."
In 2018, the Foundation conducted a survey of investors who have investment accounts outside of retirement plans. Highlights from the survey released this month show they have a long way to go in order to fully achieve their mission.
First, the study showed that general investment literacy is still quite low. When asked 10 investment related questions, the average number answered correctly was only 4.7, and only a third of respondents were able to answer more than half of the questions correctly. Older investors, men and those with larger portfolios performed slightly better on the quiz, but even respondents with portfolios valued at over $250,000 only averaged 5.3 correct answers.
On the high end, 74% of respondents were able to correctly answer "True" when asked, "In general, investments that are riskier tend to provide higher returns over time than investments with less risk."
On the other end of the scale, only 22% of investors were able to correctly determine the answer to the multiple-choice question, "Which is the best definition of 'selling short'?" was "Selling borrowed shares of a stock."
Investors also seem confused by what types of investment fees they pay. As cited in the report, "Fourteen percent of all respondents do not think they pay any kind of fee for investing, and 17% say they do not know how much they pay.
Among mutual fund owners, nearly a third (32%) believe they do not pay mutual fund fees or expenses." Since high fees are often correlated with poor fund performance, a lack of understanding of these fees is concerning.
Another part of the study highlighted the unfamiliarity of investors with beneficial resources available to them, such as BrokerCheck or the Investment Adviser Public Disclosure (IAPD) database.
These tools can be used to research the background, experience, and regulatory history of brokers and investment advisors respectively. While 82% of respondents were aware of services such as CarFax to research vehicle histories, only 13% of investors were familiar with BrokerCheck or the IAPD database.
This writer has highlighted on several occasions that individuals don't need to be experts in order to properly manage their own investment portfolios. However, investors need to acquire at least a rudimentary understanding of basic investment concepts.
When people lack this knowledge, they are easier targets for a financial industry often looking to sell products that may be considered "suitable" for the customer but not necessarily in their best interest.
Instead of buying an annuity, consumers are sold an annuity. Instead of buying whole life insurance, they are sold whole life insurance. The difference can be subtle but substantial. To the uninformed, even real estate limited partnerships, non-traded REITs, and triple inverse ETFs can be made to sound like sensible investments appropriate for nearly everyone.
Through acquiring investment knowledge, consumers become empowered to make decisions about their finances they would otherwise delay or avoid altogether.
Take the current FINRA investor literacy quiz by visiting usfinancialcapability.org/quiz-literacy.php and then make 2020 the year you become an informed investor!
Tim Sullivan is the owner of Clarity Financial LLC, a fee-only advisory firm in Columbia, a CFP practitioner and member of the National Association of Personal Financial Advisors and has earned the Enrolled Agent designation from the IRS.