Thursday, 3 December 2009

Putting Financial Education on the Right Track's superb review (dare I say definitive critique) of the failings of current investor education programs leaves one quite depressed. It seems the result of investor education is that the average person is worse off!

Education doesn't work? At all, ever? The notion that education does not work is rather contrary to a foundation of the modern world. Saying it does not work today should not mean it cannot work.

One basic problem appears to be that current investor education programs, in the interest of being "fair" and "balanced" and presenting all alternatives, ends up suggesting that active investing, whether directly through stock picking and market timing, or through buying high-cost funds, gives the investor as good an outcome as buying and holding passive, whole-of-market, low-fee, index funds. The facts unfortunately deny such a position.

The fact is that government and regulatory organizations, who probably know the truth, are the ones in charge of investor ed. How can they be expected to say that a massive part of a huge industry is doing it wrong? It doesn't look like they are the right people to be leading the effort.

One of the interesting links from InvestorInfo is to the Financial Education Institute of Canada, a private company that provides seminars to employees. The Institute gets paid by employers. It emphasizes its product neutrality and gets the correct answer (index ETFs). We need more of that. Employers are a good path for providing better education to individuals.

There's another fix that employers are in a great position to implement. The most important investment money for individuals is their retirement savings, which flows through defined benefit or defined contribution pension plans at their employer. Two of the big faults of individual investors - 1) picking the actively-managed, high-cost funds and, 2) not saving enough - can be vastly improved through changing the default options in plans. Instead of some active fund, when a new employee enters a plan, make the default the index ETF. Defaults have been found in the USA to have a huge influence on participants' plan choices (e.g. download The Future of Lifecycle Saving and Investing conference proceedings and search for the word "default").

For the "not saving" bit, add another option: provide a little checkbox to have some or all of a pay increase go automatically to increased deductions for pension. Apparently our faulty brains find it a lot easier to commit future money than present money to savings. Money we never see we don't miss. Such defaults address one of the big gaps in making investor education useful in practice, namely that success is not just about knowing facts (like the differential performance of active vs index funds). It is also crucially about countering and avoiding bad reactions and decisions to which we are all subject, as behavioural finance research has embarassingly revealed.


Neil said...

ETFs are rarely available in employer defined-contribution plans (with defined benefit plans, of course, the individual member doesn't have much say, anyway.) Still there are often low-fee funds available, and yes, those should be the default.

Also, I think there is a fairly general mistake in viewing ETFs and Mutual Funds differently. I wish I could find the article, but I was recently reading that many investment brokers who are only licensed to sell traditional Funds are getting around that through Funds that only hold one ETF, and then the broker is able to sell their clients the "ETF" they wanted, even though the real benefit of ETFs - low MERs - isn't there (since there's a couple of middle men who need to make money).

Anyway, the point I was getting at, is there are passively managed index mutual funds available which charge MERs comparable to ETFs. And there are ETFs with high MERs that are at least somewhat actively managed. The differentiation of being traded on an exchange is not what makes these things different, yet from reading articles like yours, you make it sound like it is.

CanadianInvestor said...

Right you are Neil that the short-hand which identifies ETFs as the low-fee alternative is now outmoded. ETFs are nothing more than a holding structure and really low-cost mutual funds, such as exist in the USA through Vanguard would be a wonderful choice to have in Canada. The TD e-Series funds come closest I think. Their Canadian equity fund has an MER 0.31% - see

Bylo Selhi maintains a good list of lower cost mutual funds at

CanadianInvestor said...

Neil, look on Wealthy Boomer video series where Invesco Trimark Pres talks about launch of Powershares mutual funds that hold ETFs.

Unknown said...

The govt has thrown so much money toward the problems that it has temporarily stabilized the economy. But this comes with a lot of consequences, and the current expansion of the money supply is not sustainable because it will kill the value of the dollar and create a big inflation problem in a few years. That is why I feel gold is one of the best asset classes to invest in currently given its safe haven status and that it is denominated in dollars. Here is a further discussion on these issues and its potential effects on the Gold Price Wobbles Under $1,130 But U.S. Dollar Future Bleak, which analyzes the relationship between the dollar, the gold price, and gold mining companies as a result of the Federal Reserve's monetary policies. I thought it was especially helpful for investors to read to get a better sense of the inter-connectedness between these asset classes given all the uncertainty in the economy.

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