Trouble in the Offing : Survey Finds Few Americans Know Basics of Investing

At a time when Americans are increasingly required to make their own investment decisions, the vast majority of them are “reckless, financially illiterate and sitting ducks for investment fraud and abuse,” according to a survey released Tuesday.

The survey, believed to be the first to look at Americans’ “investment literacy,” raises troubling questions about their retirement prospects, given that Social Security is financially ailing and employers are increasingly abandoning professionally managed pension programs in favor of retirement plans that place the burden of decision making on employees.

“The appalling lack of basic financial knowledge revealed by this survey calls into serious question the ability of most Americans to make the sound, informed financial decisions that would allow them to achieve [their] goals,” said Barbara Roper, investor protection director at the Consumer Federation of America.

The Investor Protection Trust, an Arlington, Va.-based nonprofit organization created by various states to educate Americans about personal finance, commissioned the study of 1,001 investors to determine their skills and habits in buying financial products. Respondents were asked eight basic questions, ranging from whether securities insurance protects against risk of loss in a down market to how bonds react to changes in interest rates. Only 18% of those surveyed got the bulk of the questions right, while 32% got fewer than half of them right.

“These are not encouraging findings for a society that is moving increasingly to a self-serve approach to personal finance,” said Mark Griffin, an IPT trustee and director of the Utah Department of Commerce’s securities division. “This data suggests that millions of investors, particularly women and older investors, are sitting ducks for investment fraud and abuse.”

However, what may be more troubling is that investors do very little to protect themselves, according to the trust.

Nine out of 10 investors who have received professional financial advice never bothered to check the disciplinary history of their broker or financial planner, according to the survey. Two-thirds of investors have never prepared a specific financial plan, even though having one is considered the cornerstone of wise investing, Griffin said.

“It would be bad enough if we found that people were seriously wanting in terms of their knowledge about basic personal finance matters, but what we also discovered was that their behavior puts investors even more at risk,” Griffin said.

“Investors need to realize that if they don’t understand what’s going on with their investments and rely blindly on the advice of strangers, they are openly courting investment fraud and abuse,” he said.

The study, which has a margin of error of plus or minus 4 percentage points, also found a significant knowledge gap between young and old and men and women, said Diane Colasanto, the president of Princeton Survey Research Associates, which conducted the survey.

While about 25% of the men scored at the top of the knowledge scale, only 11% of the women did. Conversely, about 39% of the women fell into the least-literate category--getting fewer than four questions correct--while only 25% of the men scored as poorly.

Of investors 65 and older, 44% fell into the worst category, compared with just 29% of the 30- to 49-year-olds.

Roper of the Consumer Federation of America said the findings are particularly troubling because investing is no longer optional.

Where Social Security and monthly company pensions could support an adequate retirement in past years, people who are approaching retirement today can’t rely on either.

Increasingly, retirees are receiving lump sums they must invest on their own. Younger employees are finding that defined-benefit pension plans--which promise a set monthly payment for life--are being replaced by self-serve pensions such as the ubiquitous 401(k) programs, she said.

Meanwhile, the government has previously acknowledged that unless there are significant changes, the Social Security trust fund will run out of money shortly after the first wave of baby boomers hits retirement age.

“There is every indication that this trend is going to continue and become more important,” Roper said. “If that’s true, people had better learn this stuff.”

“Americans have become increasingly dependent on investments to save for major expenditures, such as buying a house or sending a child to college,” she said.

Roper said consumer groups share the blame for investor illiteracy. There are plenty of pamphlets on how to get a mortgage loan or choose a mutual fund, but consumer groups haven’t issued good, impartial advice about investing basics, she said.

The Investor Protection Trust, financed by a multistate settlement to resolve misconduct charges filed against Salomon Bros. in 1993, plans to ramp up its investor education program by launching a World Wide Web site on the Internet and distributing videos and brochures.

However, for the moment, investors may have to educate themselves by checking out basic financial texts in bookstores and libraries, Griffin said.

“It’s a daunting task,” he said. “But the tools are out there.”

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Are You ‘Investment-Literate’?

The Investor Protection Trust, a nonprofit investor education organization, conducted an extensive survey of 1,001 people to determine investor literacy and behavior. Its findings: Only 18% of the investors surveyed were “very knowledgeable,”able to answer at least seven of eight basic investing questions correctly; 50% were “somewhat knowledgeable,” getting four to six correct; 32% were “not too knowledgeable,” getting fewer than four questions correct.

By Gender

Men and women scored “somewhat knowledgeable” at the same rate, while men were ahead in “very knowledgeable.” Here’s how men and wome scored in knowledge:

Men

Somewhat: 50%

Very: 25%

Not too: 25%

Women

Somewhat: 50%

Very: 11%

Not too: 39%

By Age

Baby boomers scored relatively well while the young and the old did poorly. Here’s how different age groups scored:

18-29

Somewhat: 46%

Very: 11%

Not too: 43%

30-49

Somewhat: 53%

Very: 19%

Not too: 29%

50-64

Somewhat: 54%

Very: 23%

Not too: 23%

65 or older

Somewhat: 41%

Very: 15%

Not too: 44%

Note: Some figures don’t add up to 100 due to rounding

Source: Investor Protection Trust

Test Your Knowledge

Here are the eight questions posed to investors. Take the quiz and see how you fare. Answers on D3.

1. Over a period of time spanning the past 20 years, from 1965 to 1995, which of the following types of investments do you think generally gave the highest rate of return?

a. stocks

b. bonds

c. savings accounts

d. certificates of deposit

2. When an investor diversifies his investments, does his risk of losing money increase or decrease?

a. increase

b. decrease

3. Is the following statement true or false: “A no-load mutual fund involves no sales charges or other fees.”

a. true

b. false

4. If you lose money in a mutual fund that you invested in at a bank, will the Federal Deposit Insurance Corp. cover your losses?

a. yes

b. no

5. Is the following statement true or false: “The Securities Investor Protection Corp., known as SIPC, protects you from loss on investments of up to $500,000 if the stock market goes down.”

a. true

b. false

6. When interest rates go up, what usually happens to the prices of bonds?

a. bond prices go up

b. bond prices go down

c. bond prices stay about the same.

7. How do you think most full-service brokers and financial planners are paid? Are they mainly paid:

a. based on the quality of advice they offer and how much their clients earn

b. based on the amount and type of investments they sell to their clients

8. What is a “blue chip” stock?

a. a stock offered by a high-tech company

b. the stock of an established company with a history of paying dividends

c. a low-priced security usually trading for less than a dollar a share

Investment Quiz Answers

1) a 2) b 3) b 4) b 5) b 6) b 7) b 8) b

If you got seven or more answers correct, the Investor Protection Trust would classify you as “very knowledgeable.” Those answering half the questions right are “somewhat knowledgeable.” Thirty-two percent of the 1,001 people surveyed answered less than four questions correctly.