Financial knowledge and 401(k) investment performance: a case study

Abstract

We explore whether investors who are more financially knowledgeable earn more on their retirement plan investments compared with their less sophisticated counterparts, using a unique new dataset linking administrative data on investment performance and financial knowledge. Results show that the most financially knowledgeable investors: (a) held 18% points more stock than their least knowledgeable counterparts; (b) could anticipate earning 8 basis points per month more in excess returns; (c) had 40% higher portfolio volatility; and (d) held portfolios with about 38% less idiosyncratic risk, as compared with their least savvy counterparts. Our results are qualitatively similar after controlling on observables as well as modeling sample selection. We also examine portfolio changes to assess the potential impact of the financial literacy intervention. Controlling on other factors, those who elected to take the financial literacy survey boosted their equity allocations by 66 basis points and their monthly expected excess returns rose by 2.3 basis points; no significant difference in volatility or non-systematic risk was detected before versus after the survey. While these findings relate to only one firm, we anticipate that they may spur other efforts to enhance financial knowledge in the workplace.

Financial literacy, financial advice, and financial behavior

“…Another robust finding in the literature is a positive correlation between stock market participation and financial literacy (e.g., Kimball and Shumway 2006;Christelis et al 2010;van Rooij et al 2011b;Balloch et al 2015;Clark et al 2015). Specifically, van Rooij et al (2011b) document that financial sophistication is positively related to stock market participation of retail investors in the Netherlands.…”

“…Studies analyzing financial behavior in the U.S. also find that individuals with low levels of financial literacy are less likely to plan for their retirement (e.g., Mitchell 2007, 2011b). In a recent study, Clark et al (2015), using a dataset that links administrative data on investment success with financial literacy, document a positive relationship between individuals' financial literacy and their propensity to participate in a 401(k) plan as well as the profitability of the respective investments. A related strand of literature has also documented a positive relation between financial literacy and savings behavior (e.g., Lusardi and Mitchell 2011c;Chan and Stevens 2008;Behrman et al 2012), i.e.…”

“…Moreover, a number of studies has documented a positive link between financial literacy and portfolio diversification: highly literate investors tend to manage their risks significantly better than the group of low literate individuals (e.g., Calvet et al 2007;Goetzmann and Kumar 2008;Guiso and Jappelli 2008;von Gaudecker 2015;Clark et al 2015).…”

“…Calvet et al (2007Calvet et al ( , 2009 show for investors in Sweden a positive correlation between financial sophistication and account performance and conclude that richer and financially more sophisticated individuals invest more efficiently. Likewise, Clark et al (2015) document a positive correlation between financial sophistication and excess stock returns among U.S. individuals, while von Gaudecker (2015) finds that this group of retail investors is more likely to hold welldiversified portfolios. Deuflhard et al (2014) analyze interest rate levels for savings accounts of Dutch consumers.…”

“…Financial literacy, financial advice, and financial behavior 621 Walstad et al 2010;Heinberg et al 2010;Lührmann et al 2015) as well as financial behavior (e.g., Bernheim et al 2001;Servon and Kaestner 2008;Clark et al 2015;Lührmann et al 2015). The literature usually approaches the topic as follows: A particular financial education intervention is analyzed with respect to its impact on measured financial literacy and-in most assessments-on financial behavior.…”