CRCP Luncheon Agenda 2015 FINRA Annual Conference • Washington, DC

Thursday, May 28 12:15 – 1:30 p.m. Marquis Ballroom 8-10 – Level 2 Agenda 12:30 p.m. – 1:15 p.m. Welcome and Introductions

Chip Jones Senior Vice President FINRA Member Relations and Education Presentation Jill Fisch CRCP Program Academic Co-Director Perry Golkin Professor of Law University of Pennsylvania Law School

1:15 p.m. – 1:30 p.m. Final Remarks Speaker Information Jill E. Fisch is Perry Golkin Professor of Law and co-director of the Institute for Law and Economics at the University of Pennsylvania Law School. She received her bachelor’s degree from Cornell University and her law degree from Yale Law School. Prior to joining Penn, she was the T.J. Maloney Professor of Business Law at Fordham Law School and Founding Director of the Fordham Corporate Law Center. She has also served as a visiting professor at Harvard Law School, Columbia Law School and Georgetown University Law Center. Professor Fisch teaches corporations, securities regulation, corporate governance and federal courts. Prior to entering academia, Professor Fisch was a trial attorney with the United States Department of Justice, Criminal Division, and an associate at the law firm of Cleary, Gottlieb, Steen & Hamilton. She is a member of the American Law Institute. She has chaired the Committee on Corporation Law of the Association of the Bar of the City of New York, and the sections on Securities Regulation and Business Associations of the Association of American Law Schools. Professor Fisch's scholarship includes work on corporate law, securities regulation and federal courts, and has appeared in a variety of publications, including the Harvard Law Review, the Yale Law Journal, the Columbia Law Review and the Cornell Law Review. Recent projects examine mutual fund regulation, securities fraud litigation, the role of proxy advisors and securities arbitration. Chip Jones is the Senior Vice President of Member Relations and Education for FINRA. In leading the Member Relations and Education Department, Mr. Jones’ responsibilities include maintaining and enhancing open and effective dialog with FINRA member firms. Mr. Jones also oversees FINRA’s Member Education area, which includes FINRA conferences and other member firm educational offerings such as the FINRA Institute at Wharton for the Certified Regulatory and Compliance Professional™

FINRA Institute at Wharton Certified Regulatory and Compliance ProfessionalTM (CRCPTM)

(CRCP™) designation. In addition, Mr. Jones oversees the FINRA Compliance Resource Provider Program, where FINRA works with companies that offer compliance-related products and services to regulated firms at negotiated discounts. Prior to joining FINRA, Mr. Jones spent six years as Vice President of Regulatory and Industry Affairs at American Express Financial Advisors (AEFA). Previous to AEFA, he spent two years as Advocacy Administrator for the Association for Investment Management and Research (AIMR). Mr. Jones was employed by the Virginia Securities Division as a senior examiner/investigator for more than six years prior to joining AIMR. He received a master’s degree in business administration and a bachelor’s degree from Radford University in Radford, Virginia.

FINRA Institute at Wharton Certified Regulatory and Compliance ProfessionalTM (CRCPTM)

INVESTOR FINANCIALLITERACY

IN THE WORKPLACE

Jill E. FischTess Wilkinson-Ryan

Kristin Firth

FINRA Annual ConferenceCRCP Luncheon

May 28, 2015

Project Overview

• Series of experimental studies on retail investor decision-making designed to– Understand the process better– Identify potential efficacy of interventions such as investor

education or disclosure reforms– Consider need for regulatory changes if value of interventions is

limited

• Results from the first study were published last year – Why Do Retail Investors Make Costly Mistakes?: An Experiment

on Mutual Fund Choice, 162 U. Penn. L. Rev. 607 (2014) (with Tess Wilkinson-Ryan

• This presentation reports results from a piece of the second study

Retail investors make costly mistakes

• Insufficient savings for retirement• Inadequate or naïve diversification• Choosing risky or overly complex products• Excessive risk aversion• Attempting to time the market• Paying excessive fees

How much does it matter?

A study cited in the Wall Street Journal found that the average investor in all U.S. stock funds earned 3.7% annually over the past 30 years—a period in which the S&P 500 stock index returned 11.1% annually.

The Financial Literacy Story

• Many studies show that retail investors lack financial literacy

• Lack of financial literacy has been linked to poor investment performance, but

• What is financial literacy?• How much does it explain?• Can we improve financial literacy through

education?

Measuring Financial Literacy

Lusardi & Mitchell test of financial literacy:1. Suppose you had $100 in a savings account and the

interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow: [more than $102, exactly $102, less than $102?]

2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy: [more than, exactly the same as, or less than today with the money in this account]?

3. Do you think that the following statement is true or false? ‘Buying a single company stock usually provides a safer return than a stock mutual fund’

A pretty blunt test of financial literacy

Alternate explanations

• Inadequate or complex information disclosure

• Advisers with conflicts of interest• Lack of understanding / familiarity with the

task• Lack of confidence or over-confidence

Our Prior Research

• Experiment looking at investor behavior with respect to mutual fund fees

• Our findings– Investors didn’t pay much attention to fees– Investors put too much money into high fee

funds– Naïve diversification– Instructions partially helped

This Project

• Construct a more refined measure of financial literacy

• Consider alternative ways of measuring investment performance

• Evaluate the role of financial literacy and other investor characteristics in explaining investment performance

• Test the efficacy of an experimental intervention (instruction or education) –second part of this study

Our Experiment• On-line experiment – allocating funds across ten

investment options in a 401(k) retirement account with 30 year time horizon

• Incentive payment based on portfolio’s final value• Fund options and characteristics modeled on real world

options with simplified disclosure• All information provided via “clicks”• Collected data on

– Allocation decisions– Clicks– Investor attitudes and demographics– Financial literacy questions

• Subjects – Mechanical Turk

Our subjects

Percent Male 55%Median age 31Four year college degree or more 49%

Employed full or part time 63%Current annual household income under$50,000

59%

Full Group = 695Control Group = 201

Financial Literacy Index

• 15 questions (multiple choice and true/false) about investment knowledge

1)

2) Index fund performance can vary substantially depending on the expertise of the fund managers. (F)

• 4 questions on numeracy

If interest rates go up, bond prices:

a. Go upb. Go down (1)c. Are not affectedd. Unsure

36.8% percent of subjects answered correctly

40.3% percent of subjects answered correctly

Additional Investor Characteristics

• Demographics• Investing Experience• Investment Confidence• Desire to Delegate Investment Decisions

Correlation with Financial Literacy Score

Experience Score .37***

Confidence Score .45***

Delegation Score -.32***

Covariance of Attitude Scores with Financial Literacy

Outcome variables

• Simulated 30 year portfolio value (possible range - $13.478.49 to $132,676.78)

• Weighted average fee paid in year one (excluding bank account and MMF)

• Percentage of portfolio invested in Fund D (low cost equity index fund)

• Number of clicks

Covariance of Outcome Variables with Financial Literacy

Correlation with Financial Literacy Score

Total Return .42***

Total Clicks .15*

Equity Fees Paid .03

Investment in Cheap Index Fund .32***

* p<.05, ** p<.01, ***p<.001

Regression 1: Return

Coefficient Standard Error p-valueIntercept 35358.6 11436.8 .002Financial Literacy Score 1864.6*** 644.7 .004Delegation Score 32.9 447.8 .941Experience Score 3838.1*** 1413.6 .007Confidence Score 2390.3 1734.8 .170Age 279.3* 127.3 .029Sex 2774.0 3090.9 .371Education 1177.3 1120.5 .295Income 94.0 2696.1 .972

Adjusted R-squared: .251, F(8, 184)=9.4, p<.0001

Regression 2: Clicks

Coefficient Standard Error p-valueIntercept 10.9 9.8 .268Financial Literacy Score 1.1* .6 .043Delegation Score .01 .4 .972Experience Score 2.1 1.2 .088Confidence Score -5.0** 1.5 .001Age 0.0 .1 .849Sex .9 2.7 .731Education .3 1.0 .724Income .9 2.3 .699

Adjusted R-squared .050; F(8,184)=2.25, p=.026

Equity Fund Fees

Coefficient Standard Error p-valueIntercept .655 .105 .000Financial Literacy Score -.013* .006 .031Delegation Score .008* .004 .048Experience Score -.018 .013 .165Confidence Score .012 .016 .430Age -.001 .001 .228Sex -.030 .028 .272Education -.009 .010 .378Income -.019 .024 .437

Adjusted R-squared .138; F(8,178)=4.71, p=.000

Regression 4: Investment in Cheap Index Fund

Coefficient Standard Error p-valueIntercept -11.73 9.10 .199Financial Literacy Score 1.654** .513 .001Delegation Score -.127 .356 .722Experience Score 1.630 1.124 .149Confidence Score -2.048 1.380 .139Age .093 .101 .358Sex 2.297 2.459 .351Education .020 .891 .982Income 5.54* 2.144 .011

Adjusted R-squared .141; F(8,184)=4.93, p=.000

Bottom Line

• Financial literacy correlates with investor performance across multiple dimensions

• Financial literacy has explanatory power independent of experience, education, demographics

Additional Results – Clicks• Investors are not using the information

provided– 50 discrete clicks needed to access all the

information– Only 6 subjects accessed it all– 20% did not click on anything

• Real world information is more complicated, more difficult to access and less readily comparable across alternatives

• What explains this behavior?

Additional Results – Risk Attitudes• “I chose the safest policy to make sure I

didn't loose [sic] any money.” • “For 30 years, risk seems like a short-term

strategy. Conservatism will win the day here.”

• “I chose to go with the fixed income fund because it had a low risk. The other ones seemed to have a higher risk to put funds in them.”

• “I basically used the risk levels as the determining factor. I liked the low risk investments the best because they were the most secure and I was the least likely to lose any money. I may not have gained much but I at least would not have ended up with less than what I started with. From there I decreased the level of investment until I reached the most risky. For these I invested the lowest amount I felt comfortable with.”

Additional Results – Fees

• Subjects still paid too much– Optimum equity fund had fees of less than 20

basis points, yet subject paid an average of over 75 basis points

– Subjects put less but not nothing into higher fee funds

• Subjects did not look at fee information• Only 50% reported that it was important to

choose funds with lower fees

Implications

• How to get investors to make use of the information provided to them?– Possible routes – greater direction about the

nature of the task– Increasing investor confidence?

• Test the effects of education and/or instructions– Possible tailored approach – different types of

investors have different needs

Implications• Rethinking the viability of participant-directed

retirement savings• Greater responsibility/oversight of intermediaries

– brokers, employers, financial advisers• Best practices to “nudge” consumer choice as

alternative to regulation• Greater industry attention to

identifying/structuring suitable products for retail investors (consider the case of target date funds)