Investing for Survival

In investing, less is often more: For instance, less trading. Or less chasing of high-performing assets.

But there’s one case where a new study suggests more really is more, and less is less: Your financial knowledge.

Investors deemed to be more financially knowledgeable than peers enjoyed an estimated 1.3% higher annual return in their 401(k)s or other defined contribution plans than those with less knowledge, write authors Robert L. Cark, Olivia S. Mitchell and Annamaria Lusardi in a just-published National Bureau of Economic Research paper.

Is it because brainy people know the markets better? Not necessarily. Better-informed investors hold more equity exposure, the study finds, and equity investments have performed better over time.

Thus, the better-informed investor’s portfolio was also more volatile than one which slants heavily to bonds, cash or other investments. The difference was good enough for a nest egg an estimated 25% bigger by retirement, the authors write:

[C]eteris paribus, more financially knowledgeable people hold more equity in their portfolios, and hence they can expect higher risk-adjusted returns. These effects are statistically significant and nonlinear: that is, the most knowledgeable hold 11.5% more stock than their least knowledgeable counterparts and they can anticipate earning around 10 percent or one hundred basis points more (coefficient on the High Financial Literacy Index of 0.975 versus a mean of 9.142). In other words, the most financially sophisticated earn higher risk-adjusted excess returns. Since we control on respondents’ 401(k) balances, it is remarkable
that there remains a positive and statistically significant association between excess returns and the financial index after netting out past investment success ….

We show that more financially knowledgeable employees are also significantly more likely to hold stocks in their 401(k) plan portfolios. They can also anticipate significantly higher expected excess returns, which over a 30-year working career could build a retirement fund 25% larger than that of their less-knowledgeable peers. Their investment portfolios are also somewhat more volatile, exposing them to slightly more idiosyncratic risk.