How much do you know about investing? If you don’t know as much as you’d like, you have some company. A recent TIAA-CREF survey found that many American investors demonstrate a knowledge gap when it comes to basic information. For example, more than half thought it’s OK to focus on short-term financial performance when evaluating investments and almost one-third thought all of their investments had the same risk. These misconceptions could put Americans’ financial health in danger. The Cheat Sheet spoke with Dan Keady, certified financial planner and senior director of financial planning at TIAA-CREF, for more on this study.
The Cheat Sheet: Why did TIAA-CREF decide to conduct this study?
Dan Keady: While there have been many studies conducted about general consumer financial issues such as debt, budgeting and financial planning, we wanted to investigate the general population’s knowledge around more complex investment practices. Many individuals have misconceptions about investment performance and risk and we wanted to explore those topics in our 2015 Built to Perform Survey. The survey included American adults who are employed, contribute to an employer-sponsored retirement plan, or an individual retirement account, and make or share in financial decisions for their household.
CS: Which survey responses surprised you most? Why?
DK: A number of investors focus on short-term investment performance and have certain misunderstandings about the nature of investment risk. For instance, the survey found that 71% of American investors are under the impression that they can eliminate investment risk by having a diversified portfolio. While a diversified portfolio can help to manage investment risk, there is no way to eliminate it altogether. Similarly, many respondents also are unclear on how to maintain an appropriate level of risk in their portfolios. The survey found that 53% of respondents think higher risk guarantees higher returns.
That said, while there are some misconceptions and confusion about risk and performance, the majority of American investors are clear on what they want out of their portfolio. The survey found that two-thirds of investors feel it’s important to have a portfolio that is reflective of their life goals, which could be a range of milestones such as paying for college or establishing a nest egg for retirement.
The Cheat Sheet: Why are so many consumers focused on short-term financial performance?
Dan Keady: In the 2015 Built to Perform survey, TIAA-CREF found that 36% of respondents look to one-year performance as the most important indicator of an investment’s return. Furthermore, nearly half (47%), have purchased a fund based on its performance during the previous year rather than looking at its performance over the long term. It’s not uncommon for individuals to focus on the near term rather than the bigger picture, and this phenomenon is seen in saving for retirement as well. For example, TIAA-CREF’s 2015 IRA Survey revealed that one-third of respondents said short-term saving for a vacation or needed household appliance was their first priority versus the eight percent who chose contributing to an IRA. It requires a lot of discipline and careful planning to invest for the long term, which is why many individuals tend to focus on what’s right in front of them.
CS: How can this approach be dangerous for your long-term financial health?
Dan Keady: The short-term view that individuals tend to take on their investments can have a negative impact on their financial well-being. Without an accurate base knowledge of investment performance and risk, individuals will have difficulty building well-positioned portfolios to help them meet their long-term financial goals. Garnering successful returns in investments can be a coin toss if you are looking at them on a day-to-day or week-to-week basis. While no one can pinpoint where the market is going on a particular day, studying performance history over the last five to 10 years will provide sounder insights into how stable a particular investment will be.
The Cheat Sheet: What is the key to achieving your investment goals?
DK: Financial goals cannot be accomplished overnight or in a single quarter or year. The key to achieving your investment goals is to focus on the long game. When considering an investment’s return over a specific time period, look beyond its annual performance to its three-, five- or 10-year returns. By examining an investment’s long-term performance, you can see how an investment has held up under different market conditions and under different interest rates. No matter what your goals may be, it’s crucial to keep the bigger picture top of mind so you will be prepared for both expected and unexpected life milestones and events. A professional financial advisor can help you tailor a long-term investing strategy.
CS: What are some ways to increase knowledge of basic investment concepts and strategies?
DK: Individuals can start with their employers to see what resources are offered through their retirement benefits package. There are also many tools and calculators online and through the websites of financial organizations that individuals can access. But a sure-fire way individuals can increase their understanding of basic investment concepts and strategies is through professional financial advice. Depending on your preference, financial advice can be accessed through in-person meetings, over the phone, online tools and calculators, online articles, brochures and other written materials and videos.
CS: Anything to add?
DK: Interestingly, the survey also found that there are generational differences in how investors respond to market volatility. As mentioned, 36% of all respondents said that market volatility is the most likely reason they would rebalance their portfolio. Only 15% of the Silent Generation (age 70 and older) said they would follow this approach. This is likely because they have lived through many ups and downs in the financial markets throughout the course of their lives. Other generations appeared more keen to rebalance in light of instability – 32% of Generation Y respondents said they would rebalance due to market volatility, with baby boomers and Generation X at 37% and 41%, respectively. It’s crucial for investors at all stages of life to understand key investment concepts – it’s never too early or too late to increase your knowledge on investment strategies.