More knowledgeable investors tend to make smarter savings and investment decisions that further increase their wealth. A recent study of Federal Reserve employees, who are admittedly more financially savvy than the general population, found that people who were best able to correctly answer five financial literacy questions saved more for retirement and made more prudent investment decisions.
The National Bureau of Economic Research study found that basic financial knowledge influences the savings and investment decisions employees make. “More financially knowledgeable employees are also much more likely to participate in their retirement saving plan, contribute more of their salaries and hold more equity in their defined contribution retirement accounts,” according to the report. The questions used to assess financial knowledge were about a simple interest rate calculation, inflation, stocks and risk diversification, the tax treatment of retirement account contributions and the effect of employer matching contributions.
Here’s how the most financially literate employees invest:
Automatic contributions. Enrolling in the retirement plan and having the money directly deposited in a retirement account is the most efficient way to save for retirement. The majority of Federal Reserve employees (84 percent) save in a workplace retirement account, according to the NBER report. Workers who are able to answer four or five financial literacy questions correctly are 13.4 percentage points more likely to be contributing to the plan, and people with two or three correct answers are 6.8 percentage points more likely to be saving in the retirement plan, compared to less financially literate employees. Older and married employees also have higher participation rates.
Higher savings rates. Federal Reserve employees who save in a retirement plan contribute an average of 8.7 percent of their pay. “Being more financially literate is associated with a higher contribution rate to these plans,” NBER found. Individuals who can correctly answer four or five financial questions contribute 2.6 percentage points more of their earnings to a workplace retirement account than those who are able to answer one or fewer questions. And those who answered two or three questions correctly contribute 1.4 percentage points more than less financially literate workers.
Older workers also have higher savings rates. Every 10 additional years of age is associated with 1.2 percentage points more pay being contributed to a retirement account. And married individuals contribute a higher percentage of their pay to the retirement plan than single people. The majority of employees contribute to a traditional tax-deferred retirement account, but 8 percent save in an after-tax Roth account and 9 percent contribute to both types of plans.
Sticking with stocks. Sometimes you have to be willing to accept a reasonable amount of risk to help your nest egg grow at a faster rate. Federal Reserve workers invest about 57 percent of their retirement savings in equities. The most financially knowledgeable workers have 14.6 percentage points more of their retirement savings in equities than the workers who answer the fewest questions correctly. “Even those with intermediate knowledge hold more in stocks than those who are less financially knowledgeable,” according to the NBER report.
Higher paid employees typically take on more risk in their portfolios. An additional $10,000 in annual earnings is associated with a 1.4 percentage point increase in equity in a retirement account. Men and married workers also tend to hold riskier assets. Older workers typically select more conservative investments, with each 10 additional years of age being associated with 5.7 percentage points less invested in equities.
Keep learning. Additional education can produce further financial results. Federal Reserve workers who participated in the financial literacy survey subsequently received educational materials about their employer’s benefit offerings. Workers who weren’t saving in the retirement plan at the time of the survey were 4.6 percentage points more likely to start contributing to the retirement plan in the following six months, and those already saving were 4 percentage points less likely to drop out of the plan.
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What Smart Investors Know That You Don’t originally appeared on usnews.com
