The research report, “Financial Knowledge and 401(k) Investment Performance,” says risk-adjusted annual expected returns are 130 basis points (BPS) higher for the most
financially knowledgeable retirement plan participant than for the least financially knowledgeable. The more
financially knowledgeable participants hold more equity in their portfolios and
hence can expect higher risk-adjusted returns. The most knowledgeable hold
11.5% more stock than their least knowledgeable counterparts, and they can anticipate
earning around 10% more, the research found.
In addition, the expectation of significantly higher excess returns over a 30-year
working career could help the more knowledgeable build a retirement fund 25% larger than that of their less-knowledgeable
The report was written by Robert L. Clark of North Carolina State University, Annamaria Lusardi of George Washington University, and Olivia S. Mitchell of the University of Pennsylvania. The researchers surveyed more than 20,000 employees of a large financial institution, from across the U.S., about
their financial knowledge in the areas of interest rates, inflation, risk, tax
offset and matching employer contributions. Employees who participated in the institution’s 401(k) plan were offered stock and bond index choices, target-date funds (TDFs), lifestyle funds,
international and emerging market funds, and a real estate fund as investment options. A 10-year
period of historical net returns for these employees was examined, with the
paper’s authors computing each participant’s equity allocation and portfolio
performance metrics as of 2013.
The researchers admitted that their estimates of the positive association between financial knowledge and
investment returns may be understated, as survey respondents at
the financial institution were likely to be better informed than non-respondents,
implying that a stronger and more positive relationship between knowledge and
returns likely holds in the work force as a whole. Additionally, the institution
provided relatively few pension investment choices, and many of those were index
funds. “Where more complex investment menus are available, it can be surmised
that the measured effect of financial knowledge would be even larger,” the researchers wrote in the study report.
The researchers say it is premature
to make any policy recommendations based on their findings, as
more research is needed to evaluate whether the improvements in investment performance
noted in the paper are sufficiently powerful to motivate greater efforts
in financial education for employees. Costs of providing such financial knowledge should also be considered.
Information about how to purchase a copy of the research report
can be found here. A free version of the report is available here.