Another nod to the IFIE-IOSCO Conference on investor education. I reference a talk by Lewis Mandel Ph.D. about the challenges of investor education. His main points, which I wholly agree with:
Investor education content is not sticky: if information is not sticky (does not appear to be well retained), investors are not going to reflect, question or fully understand content and disclosure, especially with important messages about complex investments.
Adults are difficult to reach – this is to do with the fact that it is extremely difficult to incentivise adults, who have little interest in financial “stuff”, to educate themselves, or to turn up to educational events. So a lot of this arm’s length investor education practised by regulators is just not going to work.
The best time to educate investors is at the point of interaction – when they are discussing financial issues, recommendations, strategies, risk, risk profiling etc. This is very much my own stance on investor education, which means that the most important education is going to be delivered by the adviser/advisor and his or her firm.
But, I want to go further.
Just what are we talking about when it comes to financial education, especially when we are dealing with complex financial products?
Are we talking about the type of education that would allow an investor to analyse a stock or a mutual fund, construct a portfolio, develop asset allocation benchmarks or valuation driven style tilts in portfolios or analyse a complex “portfolio product”? Because if the advisor suitability and education responsibility starts and stops at the product, this is exactly what we are talking about, whether we realise it or not.
It is important to realise that complex products are developed largely because financial advisors do not possess the expertise needed to construct the outcome intended by a complex product and many are beyond the sophistication of advisors themselves. But investors, in the absence of a best interests/fiduciary type standard need to understand them fully in order to be able to accept them.
Most investors will most likely never ever fully understand complex products (they may absorb the marketing superlatives, perhaps), but will never fully understand their complex dynamics. Complex products often have unintended portfolio impacts: for example, an investment that provides market upside but not downside will often provide no yield, will be illiquid over the period and will more or less absorb the equity risk premium in charges. Including it in a portfolio will impact liquidity and yield, risk and return forcing compensating adjustments throughout the portfolio that invalidate the inclusion of the product.
And the problem is not limited to complex products since Investors are often given too little information to fully understand even the most simplest of products.
Within a transaction driven model with limited advisor/sales person responsibility, once you move out of the realm of low cost, well diversified, passive investment vehicles (a state you will never be in a transaction model) to the realm of leverage, complex and active, you are moving into the killing fields.
Are we talking about the generic type of education that explains the basics of investment and investment risk, how an advisor will structure their portfolio (their fundamental disciplines and approaches) to meet the client’s financial needs and risk profiles, how the portfolio would be expected to perform during different market and economic conditions, and the risks that have been built into the modelling where withdrawal management is important.
I believe that we are really talking about a constrained form of education that will allow the investor to understand basic fundamentals, to complete a fairly involved, but not rigorous, interactive risk profile and risk preference assessment, to understand the key factors which differentiate the advisor and the way they work, so that they can accept the risk/return profile of a given wealth management solution. This constrained form of education will develop over time as advisor and client interact through reporting and newsletters. The advisor takes responsibility for the process and its communication and the investor for accepting the recommendation given the integrity of the process and the communication, but the investor is not responsible for the process, the structure, the risk/return management or the product selection. Investors responsibility is dependent on advisor responsibility.
Unfortunately education of the investment process and the wealth management solution, in Canada, is not a requirement of current retail advisory relationships, but rather a responsibility of investors. The KYC notes the investor’s experience and knowledge, overriding the responsibility to educate, as a precursor to what types of products can be recommended within that knowledge base. Information is limited to quite restricted product information + at times disingenuous (my opinion) marketing material.
Most communication is really disclosure and not product/investment education, and this disclosure provides no practical framework through which the investor can interpret the product information with a view to integrating it into their portfolio, even if they had the expertise and had perused the basic literacy information on regulatory directed educational web sites.
Current mandated communication leaves out vast amounts of the story, both content and structure. It is not just the content of communication that is lacking, but the elucidation of frameworks that would allow investors to process the content, if they had the expertise and ability in the first place. The transaction driven framework and its delegation of responsibilities is setting the investor up to fail.
Focussing financial education at the point of sale is part of the solution, but financial education at the point of sale will be meaningless unless financial advisers/advisors are forced to take fiduciary type responsibility for the processes, the communication and the product selection. And within this structure educational communication itself should be constrained to a basic understanding of the generics of the structure and the content, with responsibility for the integrity of the processes and the communication of those processes resting with the advisor/adviser.
Lewis Mandel web page – Articles and Books on Financial Literacy, Attitudes and Behavior (from most recent)
Proposal – To minimize devastating financial mistakes, focus financial education at the point of sale. This is more or less the text of Lewis Mandell’s talk at the IFIE IOSCO Conference.