How much higher are smart investors’ returns?News added by Benefits Pro on July 1, 2014

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Joined: September 07, 2011

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By Chuck Epstein

Common sense suggests that investors with greater financial knowledge will earn higher returns compared to less-knowledgeable investors, right?

The Wharton School has put out a paper that now tells us how much higher.

Annual returns, it says, are 130 basis points higher for the most financially sophisticated compared to the hoi polloi.

The paper, “Financial Knowledge and 401(k) Investment Performance,” cited three main reasons for this disparity.

First, it found that more financially sophisticated people are more likely to plan and save for the future. Second, researchers said more knowledgeable investors are more aware – and better managers – of the fees and charges associated with financial products. Third, more sophisticated people recognize the higher return history of stocks over other asset classes.

The paper said this was an important topic for research since 401(k) plans, the most common form of DC plans in the U.S., increasingly require individuals to assume more responsibility for managing their individual retirement accounts. Expanding financial education for individuals becomes “increasingly critical for national retirement wellbeing in an aging world,” the paper said.

In the 1980s, about 40 percent of U.S. private-sector retirement contributions went to DC pensions. By 2000, 90 percent of contributions were flowing to DC retirement accounts.

‘Unique New Dataset’

The Wharton study focused on financial knowledge and investment performance using a “unique new dataset” from a large, unnamed financial institution covering over 20,000 individuals across the U.S.

This institution offers DC retirement plans with a fund lineup that includes stock and bond index choices, target date funds, lifestyle funds (conservative, moderate, aggressive), international and emerging market funds, and a real estate fund.

The institution provided researchers with contribution rates and investment allocations across the fund lineup, which was linked to fund returns data. Using this information and 10 years of historical net returns for the investment menu, researchers computed each participant’s equity allocation and own portfolio performance statistics as of 2013.

An online to survey to measure investment intelligence was then conducted using scenarios on the topics on taxation, inflation, diversification, risk, interest rates and matching contributions.

What the researchers found was that people who scored lowest on the survey metrics were less likely to hold stocks. The least informed held about 49 percent of their retirement assets in equity, while the most informed held 66 percent.

The study also found that expected risk-adjusted returns “appear somewhat lower for the least knowledgeable, compared to the most knowledgeable.”

The net result was that applied financial knowledge yielded “a substantial difference (in returns), enhancing the retirement nest egg of the most knowledgeable by 25 percent over a 30-year work life.”

But there is still room for improvement, the study fund, since “the most financially sophisticated … diversify portfolios marginally less well than their less-knowledgeable peers.”

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