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Donald Marron

Investors lack basic financial literacy, study finds

Investors in the US are flying blind, according to a new report. Many fail to grasp compound interest, don’t understand fees and other investment costs, and aren’t aware about the risks of investment fraud.

By Guest blogger / September 4, 2012

A woman counts her US dollar bills at a money changer in Jakarta in this June 2012 file photo. According to a recent report, most US investors lack basic financial literacy, including an understanding of compound interest, basic risks, and fees.

Beawiharta/Reuters/File

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“American investors lack basic financial literacy,” according to a new report from the Securities and Exchange Commission (much of which is based on an earlier report by the Congressional Research Service at the Library of Congress). Many fail to grasp compound interest, don’t understand fees and other investment costs, and aren’t aware about the risks of investment fraud.

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Donald B. Marron is director of economic policy initiatives at the Urban Institute. He previously served as a member of the President's Council of Economic Advisers and as acting director of the Congressional Budget Office.

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From the report summary:

According to the Library of Congress Report, studies show consistently that American investors lack basic financial literacy. For example, studies have found that investors do not understand the most elementary financial concepts, such as compound interest and inflation. Studies have also found that many investors do not understand other key financial concepts, such as diversification or the differences between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns. Moreover, based on studies cited in the Library of Congress Report, investors lack critical knowledge about investment fraud. In addition, surveys demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population. The Library of Congress Report concludes that “low levels of investor literacy have serious implications for the ability of broad segments of the population to retire comfortably, particularly in an age dominated by defined-contribution retirement plans.”

The report goes on to discuss ideas for increasing financial literacy and increasing the transparency of fees and other investment costs.

People sometimes talk about financial literacy as though the goal is helping people choose their own investments. That can be helpful, but the report rightly discusses another goal: improving consumers’ ability to work with financial advisers.

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