Back to School - Holdun

Normally I would have waited until August to write this at the beginning of the school year but the issue of financial literacy which I have touched on before demands immediate attention, so off to summer school we go.

I read with some degree of alarm a recent study published in the USA by the Library of Congress for the Securities and Exchange Commission as to the state of financial literacy in that country. The conclusion was that …” investors do not understand the most elementary financial concepts such as compound interest and inflation….diversification or the difference between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns”. In essence most investors don’t know what they are doing, a rather alarming state of affairs for those trying to plan for retirement. Even worse, many investors display what behavioral-finance experts call overconfidence. They believe they’re more knowledgeable than that actually are. Only a third of Americans can answer the big three questions of financial literacy correctly: how compound interest works, the impact of inflation and the role of risk diversification. And barely one of every four Americans over 55 had even a rudimentary understanding of stock and bond prices, risk diversification, portfolio choice and investment fees. This isn’t just academic. Investors who know more about finance are more likely to plan for retirement. Also, the financially literate are more likely to invest in stocks as they know that over the long run, the only way to increase wealth is to have a decent chunk of their wealth allocated to stocks.

What is the cost of this financial illiteracy? Dalbar, a market research firm has reported that investors lag badly behind the stock market indexes. Over the past 20 years, the S&P500 has gained an average of 8.2% annually, but equity fund investors earned only 4.7%. That annual gap of 3.5% cost investors an astounding $286 billion over that timeframe. The major contributors to this underperformance are fund expenses and fees (paying too much) and investor behaviour (market timing, panic selling, buying high).
Sure, some of this self-destructive behaviour is emotional, but it can be overcome by basic financial education.

In finance, as in other areas, knowledge is power so pack up your books* and go back to school.

* A good starting point if you are so inclined is to purchase any of the following books.
* Investing for Dummies
* Personal Finance for Dummies
* Stock Investing for Dummies.

In spite of the insinuation, these books are very helpful and once you have read them, pass them along
to your children so they can get an early financial education.