July 3, 2014
Financial Savvy Means More 401k Returns
Financial knowledge is critical to one’s retirement security, finds a new study showing that 401(k) plan participants who scored higher on a test of their financial knowledge earned an additional 1.3 percentage points of investment returns annually on their retirement accounts.
Over a 30-year working life, that higher rate of return would add 25 percent to total savings at retirement.
Readers can take the quiz by clicking here; answers appear at the end of this blog post.
Americans now live in a 401(k) world: 90 percent of all contributions flowing into employer retirement plans today go into 401(k)s or other defined-contribution plans. That compares with just 40 percent in the 1980s, when defined-benefit pensions were still prevalent.
Previous studies demonstrated that financially literate people have more wealth or that they gravitate to investments with lower fees, which can boost the share of returns going directly into investors’ portfolios.
This new study – by Robert Clark at North Carolina State University, Annamaria Lusardi at George Washington University, and Olivia Mitchell at the Wharton School – adds to the literature by connecting financial knowledge to actual investment returns. (The researchers used risk-adjusted returns for 10 years, a period of market highs and lows ending in September 2013.)
They analyzed returns for 2,763 employees from a major financial institution and then subjected them to a quiz on their financial knowledge. Each employee was scored on a Financial Knowledge Index, based on his answers to five basic questions about the following topics: interest rates, inflation, risk, tax offsets, and the employer match.
The Financial Knowledge Index ranged from 0 to 5, and the average score was 3.7. Just one-third of those tested got all five questions right.
Since the employees work at a financial company, they are likely to be more knowledgeable than the general population. But the impact of this over-educated sample would only tend to “underestimate the results that would be obtained” if all U.S. employees had been sampled, the researchers said.
The higher returns earned by people who are more financially sophisticated, they conclude, support the contention that financial literacy can be “a driver of wealth inequality.”
Answers: 1. More than $110; 2. Less than today; 3. False; 4. Decline by $75; 5. Increase by $200.