In 2018, the Financial Industry Regulatory Authority (FINRA) enacted a rule requiring brokerage firms to make a reasonable effort to obtain a trusted contact for all retail account owners. A “trusted contact” is defined as an individual who can be contacted in limited circumstances – if the firm has reason to believe the account may be subject to financial exploitation or fraud, for example – to discuss the welfare of the account owner.

Importantly, while brokerage firms are required to make a reasonable effort to obtain a trusted contact, the decision of whether to do so rests with the client. This raises a question: What factors make investors more likely to name a trusted contact for their investment accounts? Specifically, does having a higher level of financial literacy make them more likely to do so?

To explore the question further, we drew a sample of 2,046 respondents from the 2021 National Financial Capability Study (NFCS) – which in 2018 began to ask respondents whether they had named a trusted contact for any of their investment accounts – and found that roughly 40% reported having done so.

We then set about examining the relationship between financial literacy and naming a trusted contact by assessing respondents’ objective knowledge (via a test covering basic financial concepts such as inflation, compounding, an interest rates) and subjective knowledge (measured by asking respondents to rate their overall financial knowledge on a scale from 1 to 7).

Respondents were also asked a series of questions to gauge their attitudes and beliefs on investment fraud and risk-taking. For example, respondents were asked to rate:

• How concerned they are about losing money due to investment fraud
• How confident they are that U.S. financial markets are effectively regulated to protect investors from fraud and abusive sales practices
• How willing they are to take risks when investing

Lastly, respondents were asked to rank how much they relied on various sources (e.g., professional advisors; brokerage firms; investment clubs; and friends, colleagues, or family member) and mediums (e.g., traditional media, social media, online resources, podcasts, etc.) for investing information.

Examining the findings

Somewhat surprisingly, a negative relationship was found between objective knowledge and naming a trusted contact. One possible explanation may be that respondents with higher levels of objective knowledge had already taken steps to address their financial needs in the event of incapacity, such as transferring assets to a revocable living trust or preparing a durable power of attorney. Assuming these actions had been taken, naming a trusted contact may have been deemed duplicative and no longer necessary.

Another potential reason is that the quiz used in the NFCS to gauge objective knowledge may not have accurately reflected respondents’ knowledge of the risks and mitigation tools associated with cognitive decline. Rather, the questions were focused on fundamental financial concepts such as diversification and the cost of credit.

As expected, a positive relationship was found between subjective knowledge and naming a trusted contact. Subjective knowledge entails not only possessing the prerequisite knowledge but also having the confidence to successfully apply that knowledge. Therefore, it makes sense that respondents with high subjective knowledge were confident in their ability to review, complete, and submit the necessary paperwork to name a trusted contact, and to select an individual who, if contacted, would act in the account owners’ best interest.

Additionally, respondents who worried about being victims of investment fraud and who believed the security markets were effectively regulated were more likely to name a trusted contact.

Implications for financial professionals

There are several takeaways for financial services professional to consider based on this study’s findings.

First, most investors have not named a trusted contact for their investment accounts. This low adoption is surprising since the election is easy to make, can be changed at any time and, unlike a power of attorney, does not require the assistance of tax or legal advisors. If many investors are able to master financial topics such as inflation, compounding, and diversification, it stands to reason that they should also be able to understand the benefits of naming a trusted contact. Clearly, something is amiss. Perhaps the disconnect lies in the communication methods used by many brokerage firms.

Educational materials that explain the role and responsibilities of being named a trusted contact could also be helpful. These materials may serve as a prompt for investors to begin discussions with prospective family members and friends. A targeted approach to investor communications could also prove beneficial. For example, millennial investors are not likely concerned about cognitive decline, but the benefits of naming a trusted contact because of being unreachable due to extended travel or a natural disaster could be relevant for this age group.

One final takeaway from the study is that, when asked to rank how much they rely on various sources for investing information, the only source that was positively related to naming a trusted contact was a professional advisor. This finding is a strong endorsement of the value of working with an advisor for a wide range of financial considerations.

IMPORTANT INFORMATION

The information contained herein is for educational purposes only and should not be construed as financial, legal or tax advice. Circumstances may change over time so it may be appropriate to evaluate strategy with the assistance of a financial professional. Federal and state laws and regulations are complex and subject to change. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of the information provided. Janus Henderson does not have information related to and does not review or verify particular financial or tax situations, and is not liable for use of, or any position taken in reliance on, such information.