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One measure of financial literacy is the quality of portfolio decision-making in 401(k) plans. Applying a qualitative framework to a dataset of nearly three million 401(k) accounts, we estimate that 43% construct “green” portfolios with balanced exposure to diversified equities, while 26% construct “yellow” portfolios with possibly too-aggressive or too-conservative equity holdings. Another three in ten participants make egregious errors and have “red” portfolios— either holding zero in equities or over concentrating their account in employer stock. Using a subset of our sample, we estimate the costs of portfolio errors (and the potential gain from improved allocations) at roughly 60 to 350 basis points in expected real return per year, depending on the initial portfolio held. Low income, low wealth and female participants are more likely to experience the largest gains from better portfolios, given their tendency to hold less aggressive portfolios.
401(k), financial literacy, decision-making, portfolios
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Opinions expressed herein are those of the authors alone and not those of Vanguard or any other institution with which the authors may be affiliated. ©2007 Mottola and Utkus. All findings, interpretations, and conclusions of this paper represent the views of the author(s) and not those of the Wharton School or the Pension Research Council. © 2007 Pension Research Council of the Wharton School of the University of Pennsylvania. All rights reserved.
The authors thank Brigitte Madrian and Olivia Mitchell for helpful comments.
Date Posted: 17 December 2019