Archive for Sunday, October 20, 2002

Consumers should be responsible for basic financial literacy

October 20, 2002

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Do Americans know enough about personal finance?

Of course not. No need to belabor the point: Studies show that most people fail quizzes on basic questions about how to save, invest and spend.

What's to be done about it? I recently spent two days in Denver with about 150 experts on the problem academics, government officials, business types, a few journalists and leaders of nonprofit financial-education organizations. The symposium, going by the highfalutin' title The State of Financial Literacy in America Evolutions and Revolutions, was organized by the National Endowment for Financial Education, a nonprofit group.

Our solution to the financial-literacy problem ... Well, our gang didn't come up with much. It would be nice to have more personal finance taught in the schools, most agreed. And it would be great to get employers to sponsor education for their workers, many attendees thought.

But let's face it: The schools have a lot on their plates already. Financial training may look like a frill to districts struggling with reading scores and frantically searching for ways to preserve music, art and gym.

Many financial experts would like to see employees get more help managing their 401(k)s. But employers fear they'll get sued if they give workers bad advice. And employers might not want to give good advice, either not if it means employees will learn they earn too little and their 401(k)s are lousy. What employer will pay a consultant to say that?

No, workplace education is sure to serve the interests of the boss first, the 401(k) provider second and the employees last.

How, then, can people learn to deal with the bafflingly complex financial dilemmas of the day?

By being convinced, I think, that this stuff really isn't that complex after all not for most people.

The typical American household has a five-figure income and a net worth in the low six figures at most.

In other words, these folks aren't in complex situations. They don't need estate plans, children's trusts, exotic life insurance or tricky tax schemes.

People with money to invest may feel bewildered by the thousands of mutual funds, stocks and bonds available today. But, in fact, the choice is not difficult if your monthly investment contribution is less than, say, $5,000. For people with modest portfolios those worth less than $500,000 it's too risky to invest in individual stocks. Putting money into just a few stocks means putting too many eggs in one basket; choosing a lot of stocks means spending too much on brokers' commissions.

That leaves mutual funds the sensible route even if you have millions invested. While there are thousands of funds, almost all can be ignored, since research shows that long-term investors do better with simple, low-fee index funds, such as those that track the Standard & Poor's 500 or Wilshire 5000.

Suppose that over the next decade stock market returns average no more than 6 percent or 7 percent a year, as many experts expect. If so, the key to investing success will be to minimize fees and taxes. Good indexers charge less than a quarter of a percent in fees, while actively managed funds typically charge about 1.5 percent. So during the next decade, the investor in the managed fund could give up a quarter of his return to fees. In addition, managed funds generally give up more to taxes.

Bond funds can be picked the same way choose low-fee indexers.

Many investors feel lost when it comes to one of the other key financial planning issues asset allocation, or the way you divide your investments among stocks, bonds and cash (meaning stock, bond and cash "funds).

But I think most of us folk should be able to handle this without a lot of effort, or the need to turn to expensive pros. Most fund companies and brokerages have free generic guidance on this, and that's good enough.

So investors don't need fine-tuned, personalized allocation plans; they can rely on the old rule of thumb for dividing up a portfolio aimed at long-term goals such as retirement: Keep the equivalent of six months' living expenses in cash. The stock-fund portion should be a percentage derived by subtracting your age from 100 70 percent for a 30-year-old, 30 percent for a 70-year-old. The rest should be in bond funds.

People who don't have a lot of financial expertise can get most of the benefits that would come from elaborate planning by simply following a few basic guidelines:

l Pay your credit-card balance off every month.

l Buy used cars, not new.

l Have savings and investments automatically deducted from your pay or bank account.

l Keep a list of your expenses for a month and then look for places to save. Don't live a life of want; just strip out the things that aren't worth the cost.

l If you have kids or a spouse who's not financially independent, get life insurance. For most people, a simple, inexpensive term life policy is best. Avoid life insurance products marketed as investments.

That all you need to know? Well, there's always room for fine-tuning, but the basics are enough to put most people on the right track.

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