As the nation's largest demographic enters retirement in the coming years, the financial services industry will likely be presented with incredible opportunities to meet their investing needs.
But according to Mary L. Schapiro, vice chairman of the NASD and president of its Regulatory Policy and Oversight unit, equally incredible will be meeting the compliance risks associated with America's aging population.
The first risk, Schapiro said in an address to the recent NASD Spring Securities Conference in Chicago, is to assume that the nation's 75 million Baby Boomers command a degree of financial expertise that eliminates the need for intermediaries to conduct proper suitability analysis.
"True, as a group, this generation is better educated than those that preceded it," explained Schapiro, a longtime regulator whose office oversees the rulemaking and governance of nearly every aspect of the securities business. "This is the first generation that became broadly comfortable with mutual funds, with stock and bond investing, even with hedge funds and non-conventional products. But suitability is not a group analysis."
To the contrary, Schapiro offered, suitability depends upon an investor's individual circumstance. Unfortunately, many Baby Boomers are just now racing to catch up with their retirement savings.
In fact, as Schapiro noted, personal savings as a percentage of disposable income in the U.S. is 0.6%, which is the lowest since the Great Depression and far behind the 11% of Germany and 5% of Japan.
Equally disconcerting is that over half of all U.S. workers do not participate in any kind of employer pension or retirement plan, and the average balance an individual has in their 401(k) plan is just $69,000. Among employer-sponsored plan participants, one in five workers does not contribute enough to qualify for the full employer matching contribution.
"We must help them understand that chasing high returns through risky investment strategies is not the path to a secure retirement," Schapiro said.
While Baby Boomers might share some of the same suitability concerns as their parents, like illiquidity and market volatility, they'll be living much longer than their predecessors. That means, Schapiro said, Baby Boomers will need to maintain retirement income for a longer period and may also require continued accumulation of wealth during retirement.
"We cannot allow the greater wealth and financial sophistication of the aging population to lull us into a sense of complacency. Suitability challenges must be addressed one customer at a time," she remarked.
Another risk, the former SEC commissioner submitted, lies in the very product innovation that has served the financial services industry and its customers so well over the years - but not all innovative products are suitable for all investors. When a firm offers product for the first time, said Schapiro, whose group scrutinizes the marketing and advertising efforts of the industry, the firm might be tempted to market certain features without presenting a full and balanced description of the product. And brokers, she added, may not be entirely familiar with the product.
"The firm must ensure adequate training and guide the brokers' disclosure and suitability analysis," Schapiro said, noting that the NASD just recently issued a "Notice to Members" alert that suggests a number of compliance issues surrounding the sale of new products.
A third risk the NASD anticipates is a failure to recognize the status of new products under the federal securities laws. Perhaps a broker was to sell a product that combined investment with an insurance component. Would that be considered a security, or something else, Schapiro asked.
She cited equity-indexed annuities as financial products that guarantee a stated interest rate, protect against loss of principal and can earn additional interest based partly upon the performance of an index. Thus, equity-indexed annuities could be a useful tool for protecting and accumulating a Baby Boomer's wealth. But some equity-indexed annuities aren't registered as securities, and some firms allow their representatives to sell them as if they were traditional insurance products.
The legal distinction between a security and an insurance product, however, isn't always clear, and firms that keep selling them as a security could be running the risk of a "selling away" problem that has not been adequately policed.
"Moreover," Schapiro added, "equity-indexed annuities are very complicated products that do not provide the liquidity that some older investors may need. Consequently, they present disclosure and suitability issues that the firm has failed to address."
Baby Boomers aren't the only demographic phenomenon that's creating challenges for the industry. Echo Boomers, or those people born between 1974 and 1994, number 72 million and started entering the workforce about five years ago.
These Echo Boomers are beginning to collect wealth, and, as Schapiro pointed out, they might be even more confident investors than their parents, especially since their advanced Internet skills are perfectly suited to researching stocks, bonds and mutual funds.
While that might make them more apt to ignore the services of broker/dealers or financial planners, Schapiro thinks the volatility of the markets will keep those investors from acting entirely on their own. There's also the fact that they might not have the same Social Security benefits to lean on as their predecessors. If, as the current Social Security debate suggests, Echo Boomers are compelled to take greater ownership over their retirement investing, their financial decisions will take on greater importance.
"It will be incumbent upon the industry to encourage these investors to increase their savings and diligently build their wealth," Schapiro offered.
Another unique aspect of the Echo Boomer generation is the timing of their maturation relative to Wall Street's recent history. Few of them experienced the bull markets of the 1980s and the 1990s - or the collapse of the Internet bubble.
"It is possible that these investors will embrace the latest investment fad or chase the hottest mutual fund," Schapiro said. "We must teach the lessons of the past, and guide these investors along a prudent, fiscally responsible course. They do not need to swing for the fences. Better for them to understand the virtues of long-term investing and aim for a steady, acceptable return on their investment."
There exists a third demographic change, however, that hasn't received nearly the attention of Baby Boomers or their Echo Boomer cohorts: the growing immigrant population and women. Schapiro cited a recent study that compared the incomes of first- and second-generation Hispanics and found that while 11% of first-generation Hispanics had income of more than $50,000 annually, that figure rises to 27% for second-generation Hispanics.
"As their incomes rise, the immigrant population and their children can be expected to devote a higher percentage of their resources to investment," Schapiro said, adding that they'll share the same financial planning concerns as their fellow Americans, but many will be inexperienced with U.S. markets and firms will have to devote greater time and resources to education.
Such attention can pay off, too. Schapiro cited how one large firm created a special unit to reach out to the immigrant and minority population. In 2001, it began with a $500,000 budget, but within four years the unit had brought the firm 3,000 new accounts and $6 million in assets.
Women, and particularly older women, constitute another group of underserved investors, Schapiro said. Their needs are unique because they earn on average 20% less than men doing the same job; they typically exit the work force for an average of seven years to raise children or care for elderly family members, and they live an average of seven years longer than their male counterparts.
Interestingly enough, at some point in their lives, 90% of women are the sole financial decision makers, whether they never marry, get divorced or are widowed.
"Women particularly need the financial education and skills necessary to prepare for their own retirement," Schapiro said.
For its part, the NASD has set up financial education grants to serve both the immigrant and the aging female populations. That's on top of the $1 million worth of general investor education grants it set aside last year alone. The regulator is also continuing to advise the investing public on emerging issues through its "Investor Alerts" forum.
In the end, Schapiro intimated, the onus is on the investment industry to manage the risk and capture the opportunity that is the ever-shifting demographic in America.
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