Financial Savviness Linked to Better 401(k) Returns

Employees who improve their financial knowledge have a better chance of improving the investment returns on their retirement accounts, a paper published by the National Bureau of Economic Research (NBER) suggests.

The research report, “Financial Knowledge and 401(k) Investment Performance,” says risk-adjusted annual expected returns are 130 basis points higher for the most financially knowledgeable retirement plan participant than for the least financially knowledgeable. The more financially knowledgeable participants hold more equity in their portfolios, and hence can expect higher risk-adjusted returns. The most knowledgeable hold 11.5% more stock than their least knowledgeable counterparts and they can anticipate earning around 10% more, the research found.

In addition, the expectation of significantly higher excess returns over a 30-year working career could help the more knowledgeable build a retirement fund 25% larger than that of their less-knowledgeable peers.

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The researchers surveyed more than 20,000 employees of a large financial institution from across the United States about their financial knowledge in the areas of interest rates, inflation, risk, tax offset and matching employer contributions. Employees who participated in the institution’s 401(k) plan were offered stock and bond index choices, target-date funds, lifestyle funds, international and emerging market funds, and a real estate fund as investment options. A 10-year period of historical net returns for these employees was examined, with the paper’s authors computing each participant’s equity allocation and portfolio performance metrics as of 2013.

The researchers admitted that their estimates of the positive association between financial knowledge and investment returns may be understated, as survey respondents at the financial institution were likely to be better informed than non-respondents, implying that a stronger and more positive relationship between knowledge and returns is likely to hold in the workforce as a whole. Additionally, the institution provided relatively few pension investment choices, many of which were index funds. “Where more complex investment menus are available, it can be surmised that the measured effect of financial knowledge would be even larger,” the researchers wrote in the study report.

The researchers say it is premature to make any policy recommendations based on their findings, as more research is needed to evaluate whether the improvements in investment performance noted in the paper are sufficiently powerful enough to motivate greater efforts in financial education for employees. Costs of providing such financial knowledge should also be considered.

Information about how to obtain or purchase a copy of the research paper can be found here.

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