'I.Q. Quiz' Shows Knowledge of Investment Basics Lacking

KANSAS CITY, MO, April 7, 2005 -- While pundits debate initiatives designed to usher in an "ownership society," a new study suggests that improved knowledge of basic investment concepts will be key as individuals attempt to exercise greater control over their financial affairs.

According to American Century Investments' On Plan I.Q. Quiz, a 10-question test taken by more than 800 investors, knowledge of some of the most basic investment concepts is poor. Only 2 percent of the investors surveyed answered all 10 questions correctly. On average, participants selected about half of the correct responses on the multiple choice test, which was given to individuals who have investments outside of a company retirement plan.

"While the trend over the last few decades has been for Americans to assume more 'ownership' of their financial futures, many still don't grasp some of the most essential investment concepts, leaving them ill-equipped to achieve their financial goals," said Doug Lockwood, vice president of Investor Guidance at American Century. "Financial empowerment must begin with quality financial education and guidance."

Challenging Concepts: Rebalancing, Asset Allocation & Dollar Cost Averaging

According to the survey results, portfolio rebalancing is the concept that confuses investors most. When presented with three true statements about rebalancing, only 13 percent selected the correct response: "all of the above." While the largest proportion of respondents (37 percent) recognized that rebalancing returns the portfolio back "to its ideal asset allocation mix," they failed to grasp other aspects. They appeared most confused by the notion that rebalancing often entails selling some of the investments that have performed best and buying more of those that have lagged. In fact, only 2 percent of respondents selected this answer.

Similar to the question about rebalancing, respondents were provided with three true statements about asset allocation, yet only 26 percent selected "all of the above" as the correct answer. Most concerning is that an equal percentage of respondents (26 percent) selected "don't know" as their primary response to the asset allocation question. Approximately a third of respondents (33 percent) recognized asset allocation as "a strategy where investments are divided among different asset classes such as stocks, bonds and cash." But, they were less familiar with studies suggesting a portfolio's "investment returns over time are based mostly on its asset allocation," an answer selected by only 2 percent of respondents.

The test participants also struggled with definitions of other common investment terms and concepts. For example, more than half (56 percent) could not correctly identify the definition of dollar cost averaging as a method that involves "consistently buying equal dollar amounts of a security at regular intervals regardless of price." Interestingly, a large block of respondents (41 percent) said they simply didn't know.

Also, only 42 percent of investors were able to accurately define an actively managed mutual fund as a "portfolio that seeks to produce investment returns that are better than a specific market benchmark." Once again 41 percent chose "don't know" as their primary response when presented with four definitions.

Diversification, Tax-deferral & the Power of Compounding Understood Better

Fortunately, investors scored better on other questions related to basic investment practices. For example, 71 percent understood that a "well-diversified portfolio will experience less volatility." Also, 80 percent understood that tax-deferred means that "taxes are paid at some point in the future." Only 1 percent of respondents confused tax-free investing with tax-deferred investing, an encouraging finding.

Also, nearly three-quarters (73 percent) correctly identified the best reason for getting an early start on a long-term investment plan as "the earlier you start, the more time your investments have to work in your favor with compounding." A follow-up question specifically addressing the "power of compounding" was correctly answered by 85 percent of respondents, the largest percentage of correct responses on a single question.

Other planning-oriented questions also garnered a large percentage of correct responses. For example, nearly three-quarters (73 percent) understood that defining your investment time horizon, determining how much money you'll need to meet your financial goals, and determining your risk tolerance are three key considerations when developing a long-term investment plan.

Investors Rank Their Knowledge

Respondents' self-assessment of their investment knowledge is mixed. The largest portion of participants (31 percent) rate themselves a 3 (on a 5-point scale where a 5 is 'very knowledgeable') when asked about their knowledge of basic investment principles. A combined 30 percent rank themselves a 1 or 2, while 38 percent ranked their knowledge 4 or 5.

Specific to the current political debate about Social Security reform, investors don't expect this entitlement program to be a significant source of retirement income. Nearly half of the investors polled (47 percent) believe their "own savings and investments" will be their largest source of income after they retire. Only 13 percent report that Social Security will provide the largest portion of retirement income.

"This suggests that many investors are resigned to the possibility that Social Security — in either its current model or a new form featuring private accounts — probably won't meet their future retirement income needs, thus requiring them to take more control of their individual finances," Lockwood said. While investors seemed to do well on test questions about the benefits of establishing long-term savings plans, approximately a third indicated their current plans are lacking. Eighteen percent said they "have a plan that needs substantial work," while 12 percent indicated they have "no plan whatsoever."

"This is clearly a case of investors knowing what they should be doing but not acting on it," said Lockwood. "It's like diet and exercise. We know what must be done to stay healthy but it's hard to get started and remain disciplined."

This also was true about portfolio "diversification." While more than two-thirds of investors correctly answered the test question about the benefits of a well-diversified portfolio, 27 percent of respondents indicated their portfolios were not "diversified enough." Another 19 percent said they didn't know about their portfolios' level of diversification. The reasons most commonly given for not diversifying include: don't have enough money (39 percent); haven't given it much thought (21 percent); and, don't understand how to do it (13 percent).

Regardless of their investing knowledge and the extent to which they take the appropriate steps to establish a long-term savings plan, investors are about evenly split between those who are confident they'll reach their goals and those who are not. Forty-eight percent of investors rated themselves at a 4 or 5 confidence level (where a 5 is ‘very confident') when asked about achieving long-term investment goals. Similarly, 47 percent gave themselves a rating of 1, 2 or 3, with the 3 rating representing 30 percent of the responses.

"The results of the On Plan I.Q. Quiz, coupled with the attitudinal research and self assessment, indicate significant ambivalence by investors about their understanding of investment basics and ability to apply these concepts to their personal financial situation," said Lockwood. "If policymakers want to accelerate the expansion of an empowered 'ownership class,' the first priority should be improved financial education and assistance."

Survey Background

The results of the American Century On Plan I.Q. Quiz and self-assessment research were drawn from interviews over the Internet with 807 individuals who have investments outside their company's retirement plan in: individual stocks or stock mutual funds, individual bonds or bond mutual funds, and other mutual funds such as money market mutual funds. The survey participants were members of Harris Interactive's online panel. Harris Interactive handled data collection and data weighting functions. The results have a margin of error of +/- 3.6% at a 95% confidence level.

About American Century Investments

American Century is a leading investment manager with nearly fifty years of experience helping investors achieve their financial goals. Based in Kansas City, Mo., the company manages approximately $95 billion in assets through separate accounts, commingled trusts, subadvisory accounts and mutual funds. James E. Stowers Jr. founded the company in 1958. His son, James E. Stowers III, is chairman and William M. Lyons is president and chief executive officer. For the past six years, American Century, which employs approximately 1,800 people, has been selected as one of FORTUNE Magazine's 100 Best Companies to Work for. For more information about the company, visit www.americancentury.com.

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