New research finds most investors to be increasingly exposed to investment risk due to a lack of advanced investment knowledge.
The Financial Industry Regulatory Authority issued a news release on the findings, which coincided with World Investor Week last month.
The research, entitled “What Separates Sophisticated Investors? Risk Literacy and Investment Decision-Making,” was released by the FINRA Investor Education Foundation (FINRA Foundation) and Stanford Initiative for Financial Decision-Making (IFDM). It was based on data from 2,861 investors who hold investments outside of retirement accounts.
The study examines how the investment literacy of Americans, particularly risk-related knowledge, is tied to their decisions and financial outcomes. It introduces a measure drawing a distinction between basic and advanced investment knowledge. Researchers examined three groups (low, basic-only, and advanced investment literacy) based on their performance across 13 investment knowledge questions.
According to the findings, only 18% of investors surveyed demonstrate advanced investment knowledge, including an understanding of how different types of investment risk, such as changing interest rates and the use of leverage, can affect investors.
Those with advanced investment literacy had meaningfully better outcomes, including lower fraud vulnerability, greater retirement preparedness and a lower likelihood of engaging in costly credit card behaviors, compared to those with low investment literacy.
“This research underscores the importance of emphasizing risk-related concepts in investor education and elevating financial fraud recognition as a complementary subject,” said FINRA Foundation President Christine Kieffer. “The FINRA Foundation is dedicated to investing in this type of targeted, relevant investor education for all Americans, so that every investor is equipped to make sound decisions and protect themselves from fraud.”
“Most of the investors we studied know the basics, but very few have developed the risk-related knowledge that defines advanced investment literacy,” said Andrea Sticha, Research Director at IFDM. “That gap is exactly why investment literacy deserves its own focus. Closing it means tailoring education to where an investor’s knowledge actually stops, meeting them there with the right content and the right channel.”
FINRA detailed the key findings of the report:
- Advanced investment literacy is primarily about understanding risk: Six of the eight questions that define advanced investment literacy directly concern risk, including risk diversification, interest rate risk, the risk of buying on margin, short selling, option payoffs and priority of claims in bankruptcy. Advanced investment literacy is not necessarily about knowing more facts; it may be more about understanding risk from multiple angles.
- Advanced investment literacy is uncommon, even among active retail investors: Only 18% of investors surveyed demonstrate advanced investment literacy, while 66% demonstrate basic-only investment literacy and 16% display low investment literacy.
- Where investors get their information is tied to how much they know: Nearly three-quarters (74%) of those with low investment literacy rely on informal sources such as friends, family or colleagues, compared to 51% of respondents with advanced investment literacy. Nearly half (43%) of respondents with low investment literacy follow recommendations from social media personalities, versus just 13% of respondents with advanced investment literacy.
- Advanced knowledge—not merely basic—is tied to lower fraud susceptibility: Willingness to invest in a hypothetical, fraud-like opportunity—a guaranteed, risk-free 25% annual return every year for five years—peaked among respondents with basic-only investment literacy (54%), more than either those with low investment literacy (49%) or those with advanced investment literacy (35%). Investors with just enough knowledge to feel confident, but not enough to fully understand risk, might be the most susceptible group.
- Advanced investment literacy is linked to healthier finances: After accounting for demographic differences, investors with advanced investment literacy were nine percentage points more likely to have planned for retirement, eight percentage points more likely to have emergency savings and 15 percentage points less likely to carry costly credit card debt compared to investors with low investment literacy.
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