Naïve Americans are accused of making terrible decisions over managing investments in their 401k retirement plans.
The view is from two professors who have detailed the mistakes Americans make in selecting their retirement saving strategy.
However, their research effectively backs-up that from the Securities and Exchange Commission last year which found that many US investors fail to understand economic terms such as inflation, investment costs, diversification and compound interest.
The study by Professors Jill Fisch and Tess Wilkinson-Ryan from the University of Pennsylvania focused on how Americans plan for their 401K retirement plan.
The 401k is the American version of a defined contribution pension plan which has tax relief attached to investments.
Poor choices
The professors say the mistakes range from making poor choices on how to diversify a portfolio, paying expensive administration fees, regularly under-investing and choosing under-performing mutual funds.
They also found that investors could not distinguish between inferior mutual funds and their higher yielding counterparts but also, more worryingly, they also showed a ‘naive’ strategy on how to choose mutual funds.
The professor said in their report: “Our research raises concern that investors as well as employers do not understand what they are meant to do when investing for retirement.”
As part of their research, people were asked to invest £6,500 into a range of 10 fictional mutual funds for their 401k retirement plan with the aim of generating enough income to retire in 30 years.
The investors had all the necessary information to make their decisions including expense ratios, the fund’s holdings and the risks attached to them.
Less than skilled investors
Some of the funds were almost identical and were only different in the fees being charged.
The result showed that some of the investors were less naive and most of those taking part understood fairly well the debt-to-equity balance in their portfolios.
Most chose to invest in index funds with low fees and a low-fee managed fund.
When it came to diversifying their portfolios, many of those taking part were less than skilled at the task with many being naive in the choices and most opted to invest in all 10 funds, even though many had higher expense ratios.
The introduction of the 401k retirement plans has revolutionised the investment industry and offer a range of mutual funds for investment by employees with employers making a small contribution too.
However, critics say that many investing in 401k retirement plans are doing so without input from industry experts and that investors have poor knowledge which will mean they may not be saving enough or investing effectively for their retirement.
