The Knowledge Gap in Workplace Retirement Investing and the Role of Professional Advisors

The dramatic shift from traditional pension plans to participantdirected 401(k) plans has increased the obligation of individual investors to take responsibility for their own retirement planning. With this shift comes increasing evidence that investors are making poor investment decisions. This Article seeks to uncover the reasons for poor investment decisions. We use a simulated retirement investing task and a new financial literacy index to evaluate the role of financial literacy in retirement investment decisionmaking in a group of nonexpert participants. Our results suggest that individual employees often lack the skills necessary to support the current model of participant-directed investing. We show that less knowledgeable participants allocate too little money to equity, engage in naive diversification, fail to identify dominated funds, and are inattentive to fees. Over the duration of a retirement account, these mistakes can cost investors hundreds of thousands of dollars. We then explore the capacity of professional advisors to mitigate this problem. Using the same study with a group of professional advisors, we document a predictable but nonetheless dramatic knowledge gap Copyright © 2016 Jill E. Fisch, Tess Wilkinson-Ryan, and Kristin Firth. † Perry Golkin Professor of Law, University of Pennsylvania Law School. We are grateful for thoughtful comments from Jonah Gelbach and the extensive research assistance provided by Jackie Hamilton, Penn Law Class of 2014. We are also grateful to Patricia Albrecht and Chip Jones for coordinating our access to the broker-subjects through the Financial Industry Regulatory Association. Prior drafts of this Article were presented at the ETH Paris 1/ESCP Law & Finance Seminar, the Tel Aviv University Law & Economics workshop, the University of Texas Law & Economics seminar, the Berkeley Faculty Workshop, and the poster session of the Conference on Empirical Legal Studies and we received many helpful comments from the participants. †† Professor of Law, University of Pennsylvania Law School. ††† J.D. 2016, University of Pennsylvania Law School. FISCH, WILKINSON-RYAN & FIRTH IN PRINTER FINAL.DOCX (DO NOT DELETE) 11/28/2016 7:19 PM 634 DUKE LAW JOURNAL [Vol. 66:633 between professionals and ordinary investors. The professional advisors were far more financially literate and made better choices among investment alternatives. Our results highlight the potential value of professional advice in mitigating the effects of financial illiteracy in retirement planning. Our findings suggest that, in weighing the costs of heightened regulation against the value of reducing possible conflicts of interest, regulators need to be sensitive to the knowledge gap.