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Fund Shareholders Still Know Too Little About The Basics

By Werner Renberg

You would think that, with so much coverage of mutual funds by newspapers, magazines, television, radio, books, and Internet web sites like this -- and with the growing volume of information pouring out from the fund industry and even the SEC -- the average mutual fund investor would be better informed now than in previous years.

You would be wrong.

At least, that is the conclusion drawn from the most recent investor literacy test conducted jointly by The Vanguard Group and Money magazine.

The 1,500 randomly selected investors who participated, answering a 20-question test on mutual fund and financial market basics that was administered at 50 shopping malls across the country, had a mean score of 37 percent, far below the 48.5 and 51 percent scores on similar tests in 1995 and 1997, respectively.

"This year's test results are disappointing for the industry as a whole," John J. Brennan, chairman and CEO of Vanguard and currently also chairman of the Investment Company Institute, remarked, "but somewhat understandable given the significant influx of new fund investors in recent years." (According to the ICI, the number of households owning mutual funds has increased from 30 million to over 48 million since 1995.)

To illustrate: The lowest scores were those of investors with 3 or fewer years of experience (32 percent) and the 51 percent of test respondents who rated themselves as inexperienced (32 percent). The highest were those of investors with 11 or more years (44 percent) and those who rated themselves experienced (53 percent).
(Brennan, who joined Vanguard as assistant to CEO John C. Bogle in 1982 and succeeded him in 1996, has 18 years. When Vanguard invited him to consider an offer and leave the Johnson Wax company, he has said, he "had never heard of Vanguard.")

Other attributes of participants were also interesting. Investors in the 55-64 age group scored the highest (40 percent) while those under 35 scored the lowest (33 percent). Brennan (who just turned 46) refrained from emphasizing it, but males scored higher than females (40 vs. 33 percent), and, as the holder of a BA from Dartmouth and an MBA from Harvard, he refrained from boasting that college graduates scored higher than non-graduates by a similar margin.

Perhaps even more significant were the findings that reflected how investors bought fund shares. Those buying directly from a fund company, such as Vanguard, earned the highest score (45 percent) and those buying from brokers were next (with 43 percent) while scores of those buying through employers, financial planners, insurance companies, and banks lagged (with 37 to 35 percent).

Does this suggest that direct marketers of mutual funds or brokers do a better job of educating investors than employers which make funds available through tax-deferred plans or financial planners, insurance companies, and banks which sell funds managed by others? Or that people who prefer to deal directly with fund companies -- and to do their own investment research -- are more strongly motivated to learn what they need to know than those who prefer to deal with a sales person?

Or both?

Whatever the case, Brennan, whose own company is a leader in the dissemination of useful information on several broad investment topics via pamphlets and its web site, as well as comprehensive information about its own funds, declared that the financial services industry, in general, has work to do.

"It is clear," he said, "that we must step up our education initiatives and continue to leverage the Internet, in particular, to focus on the fundamentals of fund investing, including risk, reward, cost, and taxes."

Among the topics covered in the Vanguard/Money test:

• The best measure of fund performance and average long-run returns
• Investments that offer the best protection against inflation
• Fund expenses
• Comparative returns for major financial asset classes
• IRA, 401(k) plan, and capital gains tax rules
• Tax-exempt securities
• Bond funds' yields and sensitivity to changes in interest rates
• Indexes and index funds
• Dollar-cost averaging
• Portfolio diversification

(I'm not being more specific to avoid giving away the answers, in case you want to take the test and check your investor literacy. Vanguard will mail you a copy, if you'll phone 1-800-523-1789, or go to its web site: Vanguard.com.)

Nearly all -- if not all -- of these topics, which are frequently dealt with in these pages, are important for fund investors to know.

All are topics that anyone selling fund shares should be able to explain clearly and patiently (and in the case of changeable rules, such as those for taxes, have to keep current on). If you pay a sales person a sales charge when you buy fund shares, that's one of the services you are entitled to expect for your money.

Whether you invest on your own by dealing directly with fund companies, prefer to deal with a sales person, or only buy fund shares through your employer's plan, you can get a wealth of fundamental information from your fund companies, the ICI, 1401 H Street, NW, Suite 1200, Washington DC 20005-2148 (www.ici.org), and the Mutual Fund Education Alliance, a trade association for no- and low-load funds, 100 NW Englewood Road, Kansas City, MO 64118 (www.mfea.com). For tax questions, there is -- who else? -- the nearest office of the Internal Revenue Service.

All you have to is ask or click.