Investing Basics: What You Don't Know Is Hurting You

Traders work at the New York Stock Exchange (NYSE) in New York, U.S., Photographer: Scott Eells/Bloomberg
Scott Eells/Bloomberg

Less than 1 in 5 Americans knows that an online brokerage account can be used to invest in stocks.

That's the upshot of a new study by the financial experts at NerdWallet, whose InvestingNerd division just ran a study concluding that "4 in 5 Americans (81.4 percent) surveyed could not correctly identify the type of account to open in order to trade stocks online."

NerdWallet? InvestingNerd? These hardly sound like serious organizations, but the financial literacy situation they describe is no laughing matter.

Check Out These Stats

In a national poll conducted from Feb. 9 to Feb. 12, 2013, NerdWallet asked 869 American adults a series of 10 simple questions on a range of subjects including brokerage accounts, asset classes, investing strategies, stock trading costs, trade execution, and 401(k) plan fees.

What they found was surprising -- and even a little frightening.

Asked quite simply what kind of account they should open in order to trade stocks online, 27.3 percent (230 interviewees) had no earthly idea what kind of account they needed. (And most of the rest got the answer wrong).

  • 2.1 percent would try to buy stocks with a bank CD.

  • 6.2 percent figured a money market account could do the trick.

  • 8.2 percent said they can trade stocks through their bank savings account.

  • And 13.3 percent said "none of the above," meaning they ruled out the correct answer (a brokerage account), which was one of the options.

On the plus side, 18.6 percent of Americans did know that an online brokerage account was the correct way to trade stocks online. On the minus side, those 18.6 percent were vastly outnumbered.

Laughing All the Way to the Bank

Not everyone's upset with the results of this study, though. Fact is, a lot of people on Wall Street depend on our ignorance about the basics of investing -- and even make a living off our inability to invest for ourselves.

Studies show that as many as 80 percent of actively managed mutual funds underperform the average return on the stock market in any given year. Paid financial advisors routinely charge 2 percent (or more!) of any assets you hand them to manage. That's 2 percent of your money, vanishing, each and every year you give it to the pros to "manage" -- whether or not they earn you a profit. And if you happen to be rich enough to buy into a hedge fund, they can cost you even more.

What it Means for You

So what's the alternative? If you're not one of the 18.6 percent who already knew how to invest without calling a professional, it's time to join them. By opening a low-cost, online brokerage account, you should be able to at least match, and probably even beat, the pros at their game -- and do so at a cost measured in only tens of dollars a year.

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How? It's simple. If so many financial "professionals" are turning in performances worse than the average returns on the stock market, then you can beat them simply by matching the market's returns. The easiest way to do this is to open an online brokerage account, and buy yourself a few shares of a simple, low-cost index fund or index-fund imitating ETF -- such as the SPDR S&P 500 (SPY) ETF or "Diamond" SPDR Dow Jones Industrial Average (DIA) ETF.

You can do a lot more than just buy plain-vanilla index funds and index ETFs once your account is open, of course. But if you can beat 80 percent of mutual fund managers, and even more hedge fund managers, with this single, easy step -- that's a good day's work already.

Ready to get started? Head over to the DailyFinance Investor Center for more information.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.