Financial Literacy Among CEOs and CFOs on LinkedIn

A paper studies just how financially literate LinkedIn users are, with the so-called Big Three literacy questions as their starting point.

Numerous papers and researchers contend that Americans have low financial literacy.

Low financial literacy is associated with low levels of participation in the kinds of planning and savings decisions that are needed to build a sound financial future. Researchers at the National Bureau of Economic Research (NBER) studied these issues using an unusual set of respondents: largely tech-savvy, white-collar professionals who are users of LinkedIn, the professional networking site.

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In “Optimism, Financial Literacy and Participation,” they used the work of economists Annamaria Lusardi and Olivia Mitchell, who in 2006 designed a financial literacy quiz with three simple questions to evaluate the respondent’s knowledge of: compound interest, inflation and risk diversification. These concepts are fundamental in making informed financial decisions and are now widely used in financial literacy quizzes and papers. NBER’s researchers call the three questions “the big 3” in their paper and added two questions on: mortgage payments and the relationship between interest rates and bond pricing.

Researchers attempted to home in on retirement awareness rather than previous retirement savings, by asking respondents if they had tried to figure out how much they need for retirement. This framing avoids obvious correlation problems with age and income. Only about 3% of the sample was non-responsive, while about 85% of high-literacy respondents and around 45% of low-literacy respondents reported that they had tried to determine this amount.

Getting one additional question correct on the actual score raises the probability of answering yes to the retirement question by about 8%. Around 40% of low-literacy respondents have done this calculation; close to 85% of high-scoring respondents have done the calculation.

NEXT: What boosts the likelihood that a respondent has given some thought to retirement?

To gauge the economic significance of this effect, consider only those respondents with an actual score of 3 on the literacy test: only about 40% of those who thought they scored 2 or below had done retirement calculations, whereas 63% of those who thought they scored 4 or higher had done this calculation. In general, introducing beliefs alongside actual literacy cuts the effect of financial literacy in half and weakens the statistical significance of actual financial literacy. It appears that much of the connection between literacy and retirement planning operates through the channel of perceived literacy.

Close to 40% percent of respondents in their sample answered all five questions correctly, almost twice the average found for average U.S. citizens. But given that the sample consisted of tech-savvy, white-collar professionals, a large fraction of whom make more than twice the U.S. national average income, the paper’s authors contend it is reasonable to ask whether the financial literacy rates they measured should not be a great deal higher.

In fact, through that lens, their results reinforce the findings of previous studies: that mistaken beliefs about financial literacy may be as problematic as financial illiteracy itself.

More than a third of those who identified themselves as chief financial officers, chief executives or chief operating officers did not answer all five questions correctly.

NEXT: Perceived vs. actual financial literacy.

Like previous work, NBER’s researchers found that high-literacy respondents are likelier to exhibit productive financial behaviors: save for a rainy day, plan for retirement and pay attention to fees when choosing credit cards. However, this is mostly driven by perceived, rather than actual, financial literacy. When controlling for self-perceptions, actual literacy has low power to predict financial engagement.  

It is not that mistaken beliefs cause engagement, the researchers say, but in fact the opposite: that engagement causes mistaken beliefs. By this logic, small amounts of variation in the initial level of overconfidence or optimism could cause individuals to engage in financial decisions, and their engagement creates a type of learning by doing that in turn both imparts literacy to those who are engaged and magnifies their self-perceptions.

These results shed light on why efforts to improve financial engagement by increasing financial literacy have faced challenges. Education and advice are two channels often proposed for increasing  participation, and the results suggest that both must confront difficulties.

Because beliefs are often more important predictors of engagement than actual literacy, educational treatments that may threaten perceived literacy even as they improve actual literacy may be counterproductive in terms of their impact on increasing engagement.

Data for the paper was solicited on two days: January 20 and July 18, 2014, and a method was used to allow the researchers to isolate and distinguish optimism and self-confidence: responses that included “I don’t know” or which were unanswered were omitted. The final sample consisted of 5,814 responses.

Information on accessing “Optimism, Financial Literacy and Participation,” by Anders Anderson, Forest Baker, David T. Robinson, is on the website of the National Bureau of Economic Research.

Institutional Investors More Cautious About Alternatives

Meanwhile, advisers are more enthusiastic about alternative investments, a survey finds.

Twenty-two percent of institutional investors surveyed by Morningstar and Barron’s financial magazine plan to allocate more than 25% of their portfolios to alternative investments in the next three to five years, down from 31% in 2013.

Meanwhile, 63% of advisers say they will allocate more than 11% of assets to alternatives in the next five years, up from 39% who expressed that level of commitment in 2013.

Additionally, 45% of institutions said alternatives are “somewhat less important” or “much less important” than traditional investments, up from 28% in 2013. Nearly one-third of advisers (31%) said alternative investments are “much more important” or “somewhat more important” than traditional investments, up from 27% in 2013.

The most popular alternative choice for institutions and advisers alike are multistrategy funds, cited by 22% of institutional investors as their fastest-growing alternative strategy and by 14% of advisers.

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“Financial advisers are increasingly enthusiastic about alternatives just as institutions are becoming more cautious,” says Josh Charlson, director of manager research for alternative strategies at Morningstar. “Advisers have a far wider range of liquid products to choose from than in the past, while institutions have become less enamored because of the high fees and poor transparency of traditional hedge funds.”

Industry Growth

Growth rates in alternatives exceeded all other asset classes, despite slowing to 12.3% in 2014 from 42.2% in 2013. By comparison, U.S. open-end funds grew 2.1% in 2014 and 3.0% in 2013. In 2014, 118 alternative mutual funds were launched, up from 89 in 2013.  The multialternative category led the way with 40 fund launches, followed by 32 launches in the non-traditional bond category and 21 in the long-short equity category.

The survey comes on the heels of a report from OppenheimerFunds stating a case for the relevance of alternatives in retirement plans to properly diversify portfolios. The survey was conducted in the spring of 2015 among 149 institutional investors and 233 financial advisers. To view the complete results of the survey, click here.

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