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SEC Finds Retail Investors Too Stupid To Invest Without SEC Assistance

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This is boring but short so focus for a minute, there will be an easy quiz:

So assuming that the value of the assets in your account managed by DEF totaled $450,000, what advisory fee will you be charged? Is it:

I know, I know, you cheated: the right answer is the one highlighted in yellow and marked "(CORRECT)." But I bet you could've gotten it anyway; you passed at least one practice CFA Level 1 exam. [Update: heh, of course the SEC's correct answer is wrong too, what can you do, illiteracy for all. In my defense I just picked the highlighted correct answer.] The question is from the appendages to this super long SEC report on the state of financial literacy, and you can summarize it simply with: terrible, the state of financial literacy is terrible. The SEC's pollster polled 600 retail investors with that question and 71% of people got it wrong, all in ways that make the fees look less than they are:

There's lots of other goodness in the report, like the 2/3 of retail investors polled read "Sales charges, commissions and/or selling concessions are paid when you buy or sell mutual funds" to mean "you will not be charged a commission when you buy or sell mutual funds." These are lets say mass-retail investors, with median AUM in the $100-$250K range,* and don't go looking for any encouraging data points.

So, great. Kevin Roose reads this and says "just index bro," which fine, but it's clear that 3/4 of retail investors cannot read at a sufficient level to understand their index fund's fee disclosures, or for that matter a sentence like "put all [your] money in passive index funds." My counsel is despair, uncut.

I said yesterday that the SEC's weirdly lazy "go ahead and advertise your private placement as broadly as you want" rulemaking felt a little like the SEC saying "okay, Congress, you want lots of fraud, here you go, enjoy your fraud." I mean, yeah, read it in conjunction with this report: the combination of (1) "accredited investor" being a pretty mass-affluent designation (and sellers only needing to make "reasonable efforts" even to verify that), (2) the mass-affluent being totally incapable of reading two paragraphs of fee disclosure, and (3) ADS ON BLIMPS will mean so much joyous, joyous fraud. My guess is Mary Schapiro is sharpening her I-told-you-so stick or, even better, plotting her move to the shadiest bits of the private sector. You could imagine her running a fund-of-funds, no?

More generally one reaction I have to a lot of recent financial industry scandals is to just feel a vague sense of sympathy for everyone based on the asymmetry of worldview that the two sides bring to a transaction. When Goldman Sachs sells the City of Oakland a forward-starting Libor swap, they think - to a pretty high degree of certainty - that they're hiding the ball on something. Some day count convention is tweaked in some non-market way to make Goldman an extra basis point of profit, and after the deal signs they all high-five each other and say "boy I'm glad the assistant city treasurer didn't catch that nonstandard day-count convention that we buried in the document." But they don't think that the assistant treasurer who swapped his bonds to fixed would be surprised when rates went down and he had to keep paying the same amount. That's like - that's just what a swap is, man. That part was clear and disclosed and out in the open in a really easy-to-understand way, probably with charts and graphs, to distract from the day count.

But, nope! The assistant city treasurer didn't understand shit.** Similarly, that disclosure at the top of this post, that is ... that is pretty clear, no? I mean, I guess it'd be clearer with an example, but then people go and complain about 100-page prospectuses, so, y'know. One possible conclusion is that the difference between people who think about investments - and, more relevantly, their own fees - all day, and people who never think about investments and go to financial services professionals with dread in their hearts and fog in their minds, is irreconcilable. Despair, uncut.

One possible other conclusion is: go out there and rip some people off! This survey is among other things a careful breakdown of investors' weak points, a roadmap to deception for anyone who is not squeamish or easily bored. Start with that disclosure at the top. If I wanted to scam some people, I'd charge 6% of assets up to $200K and 0.25% of assets above that, and then go market to people with just about $200K to invest. "Look at the price break you get," I'd say, "if you just invest a few thousand dollars more." Apparently that would work.***

SEC Issues Financial Literacy Study Mandated by the Dodd-Frank Act [SEC]
Study Regarding Financial Literacy Among Investors [SEC]
SEC Study Proves That Stock-Picking Should Probably Be Left to the Professionals [DI / Kevin Roose]

* Demographics are here; you want the "ADV" column for these questions. 10% have over $1mm in investable assets; 76% own single-name stocks; 19% own ETFs; 12% own options, 9% own "retail structured products." I wanted some cross-tabbing; do you think retail investors who trade options are more or less literate than those who don't? What about "retail structured products"?

** This is not really true in that particular case; the City of Oakland are pretty clearly being opportunistic about trying to get out of a swap that they really did understand, but whatever. I'll readily believe that the normal case was "the city didn't understand."

*** General peeve of mine is people not understanding how marginal tax rates work. Do you say things like "more income will push me into the next tax bracket and actually cost me money"? Of course you don't, you're smart, or at least in the top tax bracket**** so this is not a thing you would say. But some people would, and they all took this survey.


***** Also: footnotes in footnotes!