It always saddens me when I hear about small investors having lost, perhaps irretrievably, a sizeable portion of their net worth, in investment vehicles that went wrong. While some will argue that lack of investor protection plays a key role in many such cases, poor financial literacy is also to blame.
I have been a professional investor – a fund manager – for the best part of 30 years. During that time, I have undergone a vast amount of training, passed numerous exams and read many books and articles about investing and related topics. In other words, I consider myself qualified in the practice of fund management. And yet, frequently, I come across people outside the investment industry who are only too keen to opine on the prospects for financial markets or the stock price of a particular company. I am fairly sure most non-specialists would not express an opinion to a brain surgeon or an airline pilot on how to perform their jobs. What makes investing different?
Most obviously, there are no entry barriers to investing in the way there are with the two aforementioned professions. Most know that while there is nothing to stop them setting up and managing their own investment portfolio, performing brain surgery or flying a plane without extensive training, not to mention possession of requisite natural skills, would almost certainly end badly. Furthermore, making one’s own investment decisions can more easily be considered a natural extension of other self- directed financial decisions, such as buying insurance.
Second, the fund management profession does not have a great reputation, so there may be a temptation to think one can do better than the pros. Amateur investors are increasingly aware that the average actively managed fund underperforms its benchmark index, so why not have a go oneself?
Third, successful investing can appear easy. Humans are susceptible to a cognitive bias called the fundamental attribution error, whereby they tend to attribute their successes to skill and failures to bad luck. Thus, the amateur may not only fall into the trap of thinking that investing is easy, but he may also refuse to acknowledge his own failings.
Successful investing is not easy, which is why there are and have been so few truly great investors over the decades; and why the average actively-managed fund underperforms. The Quantitative Analysis of Investor Behaviour, an annual survey conducted by US firm Dalbar, finds invariably that individual investors not only tend to be drawn more to funds that subsequently perform poorly, but they also get market timing wrong.
The role of government in investor education
If making active investment decisions is much harder than most understand to be the case, who should be responsible for conveying this message? The active management industry can hardly be expected to tell a prospective customer that he is likely making a mistake in buying one of its funds. Nor can the government – the regulator – be seen to be favouring the passive investment industry over its active counterpart.
Nevertheless, the government should be expected to play a role in investor education and improving financial literacy and does indeed seek to do this via The Money Advice Service. The website, moneyadviceservice.org.uk, is a decent attempt to provide an integrated and comprehensive public resource. It is, however, in my opinion, not sufficiently user friendly and could perhaps take a leaf out of the book of the US’s National Endowment for Financial Education and its Smart About Money service, particularly when it comes to the basics.
For example, one of the most fundamental things that beginners need to understand is the difference between saving and investing.
Smart About Money explains this very well: saving is low or no risk while investing is higher risk. The Money Advice Service makes no such distinction in its beginner’s guide and if anything appears to confuse the two. If we as a country want good financial literacy, it is imperative to get the basics right.
NB: The views expressed are those of Peter Elston at the time of writing and are subject to change without notice and do not constitute investment advice. Whilst What Investment has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.