Are Investors Getting Dumber?

This article is published with permission from InvestmentU.com.

I’ve long lamented that basic financial literacy is not a routine part of a high school education in this country. Students routinely graduate without understanding compound interest, IRAs, mortgages or why we even have a stock market.

And so they trundle out into the real world, saving little, investing poorly (or not at all) and — typically — paying 18.6% annual interest on their credit cards. Within a few years, they are deep in a hole, trying to dig themselves out, and telling anyone who will listen of the essential inequity of the capitalist system.

It can take the average person years, if not decades, to learn (if ever) how to save, invest, minimize taxes and enjoy a measure of financial independence.

Yet in a new study out of Texas Tech University, Michael Finke, PhD, CFP and his colleagues reveal that financial literacy actually worsens as we get older. The study shows that knowledge of basic concepts essential to effective money management declines by about 2% each year after age 60.

However, confidence in financial decision-making abilities does not fall. That means folks who live to age 90 are, on average, only half as smart about money as they were at age 60, but they are no less confident about investing it.

Made for calamity

Talk about a recipe for disaster. After all, nowhere is overconfidence more soundly punished than in the financial markets, where outsized optimism and big egos routinely get taken down like the Berlin Wall.

Look at just a sampling of the questions many older Americans flunked:

1. Net worth is equal to:

A. Total assets

B. Total assets plus liabilities

C. Total assets minus liabilities

2. Which bank account is likely to pay the highest interest rate on money saved?

A. Savings account

B. Six-month CD or certificate of deposit

C. Three-year CD

3. The main advantage of a 401(k) plan is that it:

A. Provides a high rate of return with little risk

B. Allows you to shelter retirement savings from taxation

C. Provides a well-diversified mix of investment assets

People who cannot answer these basic questions should not be managing their own money.

And they definitely shouldn’t be buying variable annuities, whole life insurance and long-term care insurance.

Those products are generally so complicated — so full of caveats, drawbacks, hidden fees and penalties — that even people in the industry, including the majority of those who sell them, don’t fully understand them.

Knowledge is indeed power. And financial literacy is a lifelong endeavor.

That means you should do everything you can — from reading the handful of classic investment books to learning the essential money-management principles we talk about here each day — to make sure you know as much as you can about how to boost your savings, reduce your federal and state taxes, minimize your investment costs, and achieve your financial goals with as little risk as possible.

And if you have an older relative who is losing his or her investment competence — and is therefore increasingly vulnerable to smooth-talking brokers, life insurance agents and self-styled “financial planners” — get together with close family members and intervene.

Their financial well-being — not to mention any potential inheritance — may well depend on it.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.