Mutual fund investors often lack understanding of what they own and their inherent risks, according to a new study.
A large percentage of investors who have owned passive products (48%) chose this strategy because of a belief that it represented "minimal risk," the report released Thursday by Boston-based MFS Investment Management highlights. Less than half of passive investment owners polled in the MFS Investing Sentiment Insights survey (48%) indicated knowing the correct definition with 41% saying they have "no idea." Of the 958 investors surveyed, who all have $100,000 or more in household investable assets, 38% said they thought passive investments are designed "to significantly outperform the market at any given time through research-based stock-picking."
"Some of the basic concepts are a little sketchy in the investors' minds, some relatively harmless and some more dangerous," says Doug Orton, vice president for business development at MFS. "Of people who had bought passive investments, 48% said one of the reasons they bought it was 'minimal risk' which to me is frightening. If I buy the S&P Index fund thinking it has minimal risk, next time the market is down 20% what am I going to do? I'm probably to bail at exactly the wrong time."
While the study shows some confusion on investment strategies, nearly two-thirds of investors indicating owning both passive and active investment products. Twenty percent of investors say they plan to increase their allocation to actively managed mutual funds in the next 12 months.
"The plus is they see a spot for both of them," says Orton referring to investors mixing both asset and passive products into their portfolios. "The downside is we have a lot of work to do I think educating them on the difference between the style of investment managing versus the goal or the style of the investment itself."
More Education Needed
With so many investors not knowledgeable about investment strategies, Orton emphasized the importance of fund managers and financial advisors stepping up education efforts with clients. MFS has run webcasts for their advisors' clients on basic investment principles that do not involve specific products and Orton encourages other fund managers as well as advisors run similar programs.
"It comes down to making people understand what they own and why," Orton says. "What we think of when we are defining terms and what investors think in some cases is wildly different."
Steve Rudman, managing director and head of sales at Direxion Funds, says his firm has created educational content on its website for investors about asset allocation and also will give presentations at conferences that are open to the public a few times a year. In addition, Direxion works closely with financial advisors in distributing informative material about investment concepts so that their clients can be brought up to speed.
"We try to design it so that anyone with any sense of investment knowledge can come away from it with a great understanding," says Rudman. "We really have to make sure that people are further educated and have a greater understanding of their asset allocations."
Rudman added that other fund managers he has communicated with at recent industry events have discussed the importance of investors grasping their financial strategies for the betterment of the asset management industry.
"It is part of our obligation to help investors understand these concepts better," he said.
Psychology Also a Factor
Dr. Tom Howard, CEO and director of research for Greenwood Village, Colo.-based AthenaInvest, says much of the confusion from investors about differences between passive and active strategies goes beyond just lack of education and is also psychological.
"If an investor thinks that by going passive there will be less emotion and volatility, that is a wrong choice," says Dr. Howard, who uses a behavior management approach when selecting investments for the all-short AdvisorShares Athena International Bear ETF. "There needs to be a behavior modification effort and not just education."
Millennials' View of Investing
Forty percent of "millennial" investors ages 34 and under in the MFS research define long-term investing as less than five years despite having a much longer investment window than older generations. The survey also reveals that millennials hold cash more on average (25.8%) and fewer U.S. equities (30.5%) than older investors.
Nearly half of millennials polled (46%) say they agree with the statement that they would never feel comfortable investing in the market, up from 40% in the June 2011 MFS Investing Sentiment Insights survey. Despite an improving economy, the percentage of millennials' U.S. equity allocation has dropped since 2011 from 32.7% to 30.5%.
"If you are 28 and you want to retire 30-35 years from now and you are going to be an extremely conservative investor that is not a bad choice, but you are going to save significantly more to meet the same goal or we can take more risk and keep saving what you are saving now, Orton explained. "But if the client doesn't know they are making that choice, I think there is trouble."