The Knowledge Gap in Workplace Retirement Investing and the Role of Professional Advisors

Abstract

The dramatic shift from traditional pension plans to participant-directed 401(k) plans has increased the decision-making responsibility of individual investors for their own retirement planning. With this shift comes increasing evidence that investors are making poor decisions in choosing how much to save for retirement and in selecting among their investment options. Studies question the value of efforts to improve these decisions through regulatory reforms or investor education.

This article posits that deficiencies in workplace retirement savings cannot be adequately addressed until the reasons for poor investment decisions are better understood. We report the results of a study designed to simulate the retirement investment choices faced by those responsible for their own 401(k) plans. We construct a novel measure of financial literacy in order to test the relationship between financial literacy and investment choices. We also explore the explanatory power of other investor attributes such as gender, education and investment experience.

Our research reveals strong relationships between financial literacy, investor behavior, and investment outcomes. Importantly, financial literacy provides substantial explanatory power even when we control for other investor characteristics. We conclude that greater financial literacy is associated with better investment results. This provides support for future work aimed at developing methods to increase financial literacy in order to improve retirement investment behavior and outcomes.

Keywords: financial literacy, investor behavior, investor returns, empirical research, behavioral decision research, mutual funds, investor experience, investor knowledge

JEL Classification: D18, D83, G11, G14, G23, G28, K22