2006 Annual Meeting of the Certified Financial Planner Board of Standards, Inc.
Los Angeles Convention Center
August 4, 2006
Thank you Sarah, for the kind introduction. And many thanks to the CFP Board for inviting me, and to all of you for being here. The CFP Board of Standards could not have a more effective, innovative or energetic leader than Sarah Teslik. In Washington, I watched Sarah turn the Council of Institutional Investors into one of the most effective shareholder advocacy organizations in the country. Turning her talents to the promotion of the highest professional standards for financial planners will be very much to the benefit of all of us.
You may find this hard to believe, but this is the first time I've been on the same program as a Queen and a Medal of Honor recipient. I guess I need to get out more.
This is also the first time I've spoken to this organization and I hope it won't be the last; there is so much commonality between our two segments of the financial world that we have a lot to learn from each other.
I want to talk today about a subject that is a passion of mine, and that people in the financial industry—brokers, investment advisers, financial planners, and even regulators—probably ought to focus on more than we do. We all can get caught up in the minutiae of how to deal with a rare and arcane practice or product that will never have much of an impact on most of the investor population. So let me instead draw your attention to a huge problem that we don't address nearly enough. And that is the paucity of financial knowledge among American consumers and investors.
There are many factors that contribute to this. And there are many consequences. The most pervasive consequence is that Americans, by and large, do a poor job of saving for retirement. And with the Baby Boom generation about to slam like a tidal wave into our country's system of caring for retirees, I think this is also the most worrisome consequence. Not only are there huge numbers of us in this retirement wave, but the wave is unlike anything we've seen before. Over the next 20 years, 75 million Americans will turn 60. That's 10,000 new 60-year-olds every day.
A complicating factor is the fact that our employers have been moving from the defined benefit plans that our parents had, with employers carrying the risk of performance, to defined contribution plans, which shift that risk to workers. That risk can only be mitigated with smart investing by those workers. Put these facts together and this tidal wave is looking more like a tsunami.
Let's look at the various aspects of this.
How many of you took courses in basic finance either in high school or college? Not many, I see. We all have to manage our personal finances, yet very few young adults begin their working lives having learned anything in school about how to do it. There are several reasons for this.
One is that finance courses are usually offered as electives, and most students choose not to take them. A survey of high school and college students by the Employee Benefit Research Institute (EBRI) found that "a vast majority" of students have access to financial planning courses, but only about a third take them.1
A follow-up survey found that a huge majority of children are more inclined to turn to their parents for financial information than to their schools.2 This obviously raises the question of how capable parents are as financial educators. Certainly, everyone in this room is extremely well-equipped to teach his or her kids how to manage their money. Notwithstanding any shortcomings we may have as parents, that is our bread and butter.
Unfortunately, though, there is reason to believe that parents in general are less adept at enlightening their kids about financial management than they think they are. The EBRI survey asked parents where they would advise their kids to put a hypothetical $5,000 to save for some long-term goal, and only 35 percent said they would recommend mutual funds. Only two percent mentioned IRAs.3
A second aspect of Americans' collective failure to save adequately for retirement is in the messages we get from the media. Financial magazines and Web sites regularly publish articles about the hot new mutual funds of the moment, or Where to Put Your Money NOW!, as if hopping around from one fund to another were a sound investment strategy.
Americans, by and large, aren't long on patience, which explains why soccer is not a popular spectator sport here. Who wants to wait 30, 40, 50 minutes to see somebody score a goal? And by the same token, who wants to wait decades to accumulate enough wealth to retire on when you can make a killing in the stock market right now? By exploiting this distinctly American need for instant gratification, I fear some media are unwittingly doing more harm than good.
A third unhelpful aspect of our citizenry's poor financial performance is the fact that there is a dizzying array of products being invented and marketed to investors, leaving them confused and perhaps even paralyzed in making decisions. The complexity of many new products—with elements of insurance, options, interest rate, commodity or real estate exposure, to name just a few twists—makes understanding their risks through different economic cycles a challenge, and deciding how they fit into a diversified portfolio even more daunting. Many investors feel they are simply not capable of understanding, so they toss the dice and buy an expensive, complex product they don't understand, or they give up in defeat and don't invest at all.
Those are some of the more salient issues that contribute to our society's disappointing performance in saving and investing for the long-term. The consequences of all this are profound.
The Securities Industry Association (SIA) released a study in June on retirement savings. It concluded that the problem is even worse than most people realize. Nearly half of American households have no savings at all, and two-thirds are not saving enough to get them safely through their retirement years.
Between the end of World War II and the mid-1980s, the U.S. personal savings rate rose from about 7.5 percent of disposable income to about 10.5 percent. Since then, according to the SIA study, the savings rate "has declined precipitously and is now negative." In other words, Americans are "dis-saving," as spending exceeds income.
A key factor—and a paradoxical one, at that—is the so-called wealth effect, whereby people save less as they see their net worth growing. And, my goodness, how our net worth has increased over the last couple of decades as the value of our homes that provide the roofs over our heads has itself gone through the roof. But what has occurred is a rash of home mortgage refinancing so that owners can take equity out of their houses and spend it.
Baby-boomers, are piling up debt—drawing on home-equity lines of credit, running up balances on their credit cards—at alarming rates, all to finance current consumption at the expense of long-term savings. The average American household has $8,000 in credit card debt.
When you look at personal retirement accounts—IRAs and 401(k)s—the outlook isn't much better. These are safe and reliable—if long-term and dull—and if you play your cards right, they can stand you in excellent financial stead when you retire.
Yet, only about 40 percent of employees who are eligible to participate in 401(k) plans actually do so.4 Of those who do participate, many fail to save the amount needed to take full advantage of employer matching contributions. It's been estimated that about $30 billion of "free money" is left on the table every year because of this.
Still others don't understand the danger of being too heavily invested in their employers' stock. About 17 percent of total 401(k) assets are allocated to company stock, and at the largest companies, company stock accounts for 40 percent of total 401(k) assets. Enron employees found out the hard way what can happen when you under-diversify in this way.
An even more disturbing trend is that a significant number of workers take cash out of their 401(k)s when they switch jobs. A survey of about 200,000 workers done last year by Hewitt Associates found that only 23 percent of job-changers rolled over their 401(k) money, in its entirety, to another 401(k) or IRA. Forty-five percent took cash out and 32 percent left the account to languish where it was.
Not surprisingly, two-thirds of the people who took cash distributions were young—between 20 and 29. That's not to say that older workers were substantially more frugal, though; about 42 percent of workers in their 40s cashed out upon changing jobs.
As if all this isn't combustible enough, there's also the fact that the average length of retirement has gotten longer in recent years. I'm pretty sure its impossible to say how long you're going to live, but most Americans at least think they're going to live a long, long time after they retire. If I may cite yet another study, EBRI released one in April on retirement confidence; it found, among other things, that two-thirds of current workers think they have a good shot at living to be 90.5 That's 25 years of retirement, assuming one retires at 65.
The reality is that in the early 1950s, the mean retirement age was about 68. Today, it's about 62.6
The life expectancy of an American born in 1950 was about 68 years. For an American born today, it's about 80.7
Do the math and it's clear that American workers who retire today will enjoy a substantially longer retirement period than their parents did, and will need substantially more money to get them through it.
All these factors make for a pretty worrisome picture, and we haven't even considered the issues of Social Security and Medicare solvency, the possibility that we're in a housing bubble that could burst and send home values into a freefall, and defaults skyrocketing, the outlook for the U.S. and global economies over the next 10 years, or any number of other factors that could materially affect retirees' financial security. What will happen if inflation gets out of hand? Or if interest rates increase radically?
OK, enough. I didn't come here to play the grim reaper. We need to start thinking about what we can do to put this train back on the right track. And by "we," I mean brokers, investment advisers, financial planners, regulators, educators—all of us.
And here, finally, I have some good news. It appears that economics and personal finance education at the high school level is improving, as state governments have started to wake up to the importance of this. The National Council on Economic Education reported last year that 38 states had developed standards for personal financial education, up from 21 states in 1998. Seven states now make personal finance education a prerequisite for graduation. That's not many, obviously, but the trend is upward; only four states had such a requirement in 2002. I hope—and have no reason not to expect—that the state of financial education will continue to get better.
And I know the CFP Board is trying to see that it does get better. I'm talking here about the Board's high school program, which provides teachers with course materials, volunteer speakers and other resources to use in introducing students to basic financial planning concepts. Teachers have so many demands on their time, especially now in the era of "No Child Left Behind." This service holds the potential to make it much easier for them to add personal finance to their curricula.
I'm always disinclined to toot my own horn, but NASD is very active in investor education, and I think there may be some value in my telling you about some of the work we've done and are doing. I encourage you to take a look at our Web site, nasd.com, to see the whole array of educational resources we make available.
Almost three years ago, we established the NASD Investor Education Foundation and endowed it with $31 million, all derived from disciplinary fines. The endowment received another $33 million from a court-ordered settlement of the SEC's research analyst cases, and there is another $22 million still to come from that case.
Our foundation issues grants to universities and non-profits for research and programs that help mainstream investors understand the complexities of investing and the markets. It is particularly concerned with population segments that are underserved, such as minorities, members of the armed forces and senior citizens.
A couple of relevant examples:
The NASD Foundation funded research by WISE Senior Services into why senior citizens are disproportionately preyed upon by investment scam artists. Their research came to fruition a couple of weeks ago with the release of their Investor Fraud Study.
You may have read about this in the financial press and, if so, you may have noticed that the report included some surprising conclusions. For example, financial fraud victims tend to be more optimistic and financially literate than non-victims. I'd have thought just the opposite.
The researchers also found that most investment fraud goes unreported, in part because victims are embarrassed about having fallen for it. I've been a regulator for virtually my entire career, and I thought I had seen it all. But it was a shock to learn how incredibly sophisticated are the psychological tactics that con artists use to fleece the elderly. You can find this report on the NASD Foundation's website, and I strongly encourage you to read it. If we can use this research to inform our approach to educating seniors about how to protect themselves from fraud, that will be good result.
We've also teamed up with AARP to try to do something about American workers' apathy toward investing in 401(k) plans. Obviously, participation in a 401(k) is voluntary. But a number of academic studies have found that making participation quasi-voluntary, by requiring workers to opt out instead of opt in, raises participation rates to more than 90 percent. NASD and AARP will jointly fund a public outreach plan to encourage employers to adopt this so-called automatic 401(k) enrollment, in whole or in part.
Another group of Americans we have targeted with a wealth of educational resources is the U.S. military. The fact that these people, who signed up to serve their country—even to die for it—are preyed upon by unscrupulous operators is particularly galling.
The story of how we got into this is interesting. In 2003, we found that a Texas brokerage firm was marketing a really awful product to members of the armed forces. It was a type of mutual fund called a systematic investment plan, which brokers didn't even try to sell to civilians.
Most of the firm's sales reps were retired military. They used their connections to get onto bases to make sales pitches to young officers and enlisted personnel who were not well-informed about investing. Systematic investment plans carry a front-end load of 50 percent, so their suitability for service members, indeed for any investors, is questionable at best. After we took enforcement action, the firm stopped selling them and legislation to outlaw them is now pending in Congress.
Our enforcement action took the form of a $12 million fine, of which more than $4.5 million has been returned to investors who were harmed by improper sales practices. Most of the remainder—$6.8 million—was set aside to fund a program we unveiled in February. It's called the Military Financial Education Program and it includes a wide range of education and training programs to help all military personnel—from enlisted to flag officer-better understand investing and the capital markets.
The program has many components, including seminars and workshops held on military bases around the country, and a website, saveandinvest.org, which was set up specifically for the benefit of men and women in uniform. It serves as a centralized, trustworthy source of unbiased information on saving and investing, including original content, interactive tools and games, partner resources, frequently asked questions and more.
Investor education in all its forms is a hugely important part of what we do and we're quite proud to be doing it. But at the same time, we're not so naïve as to think our education programs reach more than a small percentage of the population that could benefit from them.
So, in closing, I'd like to propose that we all draw earnestly on our knowledge and creativity to think of new and different ways to reach out to those who need to know more about managing and investing their money. I think it's no exaggeration to say that there's a crisis looming. Over the next couple of decades, millions of baby boomers are going to reach retirement age and most of them are not financially ready.
It may be that for the older ones, it's too late to do anything except wish them luck. But for the younger ones, and for their children, there's still time to help them position themselves for a productive and prosperous retirement. Let's all try to rise to the occasion.
Let me again thank the CFB Board for inviting me to be with you. It's been a pleasure. Now, I'll be happy to answer any questions you may have.
1 1999 Youth and Money Survey; EBRI, American Savings Education Council, Matthew Grunwald & Associates
2 Parents, Youth & Money, 2001; ibid
4 Bureau of Labor Statistics, 2003
5 "2006 Retirement Confidence Survey": EBRI, Apr. 4, 2006
6 "Trends in Retirement Age by Sex, 1950-2005," U.S. Bureau of Labor Statistics, Monthly Labor Review, July 1992 (including projected life expectancies for 2000-05)
7 National Center for Health Statistics, National Vital Statistics Reports, "United States Life Tables, 2003"