The Securities Litigation Expert Blog

The Disclosure Documents of Complex Investments are Hard to Read

Posted by Jack Duval

Feb 5, 2014 7:33:40 AM

This blog post continues our expert analysis of complex investments.

As discussed in yesterday's blog post, Schema Theory addresses how the lack of background knowledge and vocabulary by investors about investments limits the effectiveness of disclosure documents and verbal communication to convey meaning about their investments.

In addition to Schema Theory, which addresses the complexity of the content of a text, there is an entire scientific discipline used to evaluate the structure of the words and sentences of a text.  This disciple studies the readability of a text irrespective of its content.

Although there are many different metrics used to evaluate the readability of a text, the most common look at the average number of words per sentence and the average length of words used. The longer the sentences and words used, the less readable the text is, and vice versa.

Readability analyses have their origins with the U.S. Navy in evaluating instruction and training manuals.  They are also used extensively by book publishers to evaluate the appropriate grade level for text books, novels, and other written materials for students.

The Raygor Estimate

Readability measures can be used to evaluate investment disclosure documents.  For the purposes of this paper, I am using the Raygor Estimate, which has a readability scale from third grade to college professor levels.[1]

To set the scale in context we have compared the two sports stories from yesterday's blog post and other texts for their Raygor Estimate reading levels:

The Blackrock Basic Value Fund Prospectus

Now let us examine a risk disclosure extract from the Blackrock Basic Value Fund prospectus:

Risk is inherent in all investing. The value of your investment in the Fund, as well as the amount of return you receive on your investment, may fluctuate significantly from day to day and over time. You may lose part or all of your investment in the Fund or your investment may not perform as well as other similar investments. The following is a summary description of principal risks of investing in the Fund. 

Equity Securities Risk — Stock markets are volatile. The price of equity securities fluctuates based on changes in a company’s financial condition and overall market and economic conditions.

Foreign Securities Risk — Foreign investments often involve special risks not present in U.S. investments that can increase the chances that the Fund will lose money. These risks include:

The Fund generally holds its foreign securities and cash in foreign banks and securities depositories, which may be recently organized or new to the foreign custody business and may be subject to only limited or no regulatory oversight.

Changes in foreign currency exchange rates can affect the value of the Fund’s portfolio.

The economies of certain foreign markets may not compare favorably with the economy of the United States with respect to such issues as growth of gross national product, reinvestment of capital, resources and balance of payments position.

The governments of certain countries may prohibit or impose substantial restrictions on foreign investments in their capital markets or in certain industries.

Many foreign governments do not supervise and regulate stock exchanges, brokers and the sale of securities to the same extent as does the United States and may not have laws to protect investors that are comparable to U.S. securities laws.

Settlement and clearance procedures in certain foreign markets may result in delays in payment for or delivery of securities not typically associated with settlement and clearance of U.S. investments

The European financial markets have recently experienced volatility and adverse trends due to concerns about economic downturns in, or rising government debt levels of several European countries. These events have adversely affected the exchange rate of the Euro and may spread to other countries in Europe, including countries that do not use the Euro. These events may affect the value and liquidity of certain of the Fund’s investments.

Investment Style Risk — Because different kinds of stocks go in and out of favor depending on market conditions, the Fund’s performance may be better or worse than other funds with different investment styles (e.g., growth vs. value, large cap vs. small cap).

Market Risk and Selection Risk — Market risk is the risk that one or more markets in which the Fund invests will go down in value, including the possibility that the markets will go down sharply and unpredictably. Selection risk is the risk that the securities selected by Fund management will underperform the markets, the relevant indices or the securities selected[2]

Graduate and Ph.D. Level Disclosure Documents

The Raygor Estimate reading level for the Basic Value Fund Prospectus extract above is post-graduate freshman, first month of class. That is, this prospectus is written on the 17th grade level.

This is telling because the Basic Value Fund is a mutual fund, one of the more simple types of investments, and yet even this prospectus is written on the graduate level.

In research that is forthcoming from Accelerant, we have found that almost all investment disclosure documents are written on the graduate or Ph.D. level.

Needless to say, this puts these documents beyond the readability of the typical investor - and even some professionals.  (See our coverage of this phenomenon here.)

Combining Schema Theory with Readability statistics show why disclosure documents are so difficult for the typical retail investor to understand.

Very simply, the typical retail investor lacks the background knowledge and vocabulary to understand the content of what is written.  Furthermore the structure of typical disclosure documents makes them even more complex and less comprehensible.

Either one of these characteristics makes understanding of disclosure documents by retail investors highly unlikely. Taken together, they make it virtually impossible.  To further illustrate this point, recall the cricket story extract from yesterday's blog post. Most American sports fans would not be able to understand what was written.  Remarkably, this is true for a story that was written on the tenth grade level.

Image if the same story, with the same domain specific words, had been written on the graduate or PhD level and you have an idea of the task required of the typical retail investor to understand most disclosure documents.

In my experience, the typical investor is aware of their ignorance about investments and thus relies upon their broker or investment advisor to read and understand the disclosure documents for them.


The Accelerant roster of securities experts with complex investment backgrounds includes:

Steve Pomerantz, Ph.D.Tom Boczar, Esq., CFATom Brakke, CFAGerry Guild, CFA, and John Duval, Sr.

You can find the complete roster here.


[1]                 The Raygor Estimate uses average sentence and word length to calculate readability. The longer the sentences and words, the higher the grade level needed to understand the text.

[2]                 Basic Value Fund Prospectus, Dated October 26, 2012.  Available at, accessed May 31, 2013. 

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Topics: Complex Investments, Securities Expert, Raygor Estimate, Investment Complexity, Schema Theory

Most Retail Investors Don't Understand Complex Investments

Posted by Jack Duval

Feb 4, 2014 9:07:13 AM

This blog post continues our expert analysis of complex investments.

The lack of understanding of investments by retail investors has nothing to do with their native intelligence.  Indeed, many highly intelligent individuals who have achieved business success and often times have advanced degrees are completely innocent of the working of investments.

High intelligence and sophistication in one domain does not translate into investment acumen.  As Einstein once said, “the hardest thing in the world to understand is income taxes.”[1]

Schema Theory

This failure of domain expertise in one area to transfer to another area has been well studied and comes under the rubric of “Schema Theory”.  Schema Theory is simply the idea that prior knowledge about a topic provides a framework or structure that helps thinking about that topic.

Two core insights have emerged from the research into Schema Theory over the past 40+ years:

  •       Background knowledge is critical to understanding;[2]
  •       Without background knowledge and domain specific vocabulary, reading comprehension is severely limited.[3]

In short, the more prior knowledge an individual has about a topic, the more they can think and learn about it.  However, if prior knowledge is not present, thinking and learning about a topic is greatly reduced.

Sports Stories

As an example of how prior knowledge plays such a large role in understanding, let us consider two newspaper passages covering different sports.  (I have highlighted domain specific words and phrases.)

It was a crisp game, wrapped tautly around a few key plays. The most critical one, the one that sent the largest jolt through the crowd, came in the bottom of the eighth inning, when Daniel Murphy rapped a single into center field to drive in the decisive run in the Mets’ 2-1 victory at Citi Field.

“I know it’s the Yankees, and they’re used to playing in these games, and they’re used to all this stuff,” said Terry Collins, the Mets’ manager. “Well, for us, it’s a big win. They way we’ve been going, it’s huge for us.” 

Few things have gone right for the Mets this season, and it appeared at first that they would squander their eighth-inning scoring chance. The score was tied at 1-1 and there was one out when Mike Baxter doubled and Jordany Valdespin walked. The two advanced to second and third when catcher Chris Stewart dropped a first-pitch strike for a passed ball.

Baxter tried to score on Ruben Tejada’s sharp grounder to second base, but Robinson Cano made a nifty stop and fired home to prevent the run.

Then came Murphy, to ensure the rally would not go to waste. On a 3-1 count, he slapped a cutter from reliever Dave Robertson up the middle, sending Valdespin home. As the ball rolled into center field, Murphy lifted his bat and slammed it on the grass in foul territory in celebration. It was a bit of redemption for Murphy, who had been robbed of a home run earlier.[4]

Most Americans can understand at least part of the story above because it is about baseball and most Americans have some background knowledge about baseball.  Compare that to the following passage.  (Again, I have highlighted the domain specific words and phrases.)

In between Finn's wickets, Swann struck twice. In his second over, Kane Williamson, moving right across his stumps in an attempt to get outside the line, was beaten by some sharp turn and given out leg before by Davis. Williamson called for a review but replays suggested the ball had hit him in line and would have just clipped the top of leg stump.

Hamish Rutherford impressed for a while. He drove a couple of sweetly-timed fours off Broad - first off front and then back foot - before punching one back past Finn and then flicking Swann through midwicket for another four. But in attempting to play one that slid on with the arm, Rutherford was caught at short-leg via an inside edge and his pad by the alert Joe Root.

Later, Swann had Martin Guptill edging one that did not turn, caught at slip off the outside edge, before Taylor's fine innings was ended by a full delivery that may well have deceived the batsman in the flight, beat his drive, turned and hit the stumps. Swann became the first spinner to take eight wickets in a Headingley Test since Derek Underwood did so in 1972. [5]

Most Americans would have no understanding of the passage above.  Indeed, many would not be able to identify the sport it is describing.  However, it is very similar to the baseball story extract.  The baseball story has 23 domain specific words or phrases and the cricket story has 27.

Personally, the only meaning that I can take away from the cricket story extract is that it is about cricket – and I have played: football, baseball, basketball, tennis, volleyball, and golf, watched the Olympics over the years and have been a regular viewer of ESPN since the late 1980’s.  I include this personal anecdote because it illustrates another key fact:  even someone with a high level of generic domain experience (in this case sports) will not understand something within that domain if they have no prior knowledge or vocabulary about it (in this case cricket).

The vast majority of retail investors lack the background knowledge and vocabulary to understand investments.  For them, listening to Registered Representatives describe investments and reading disclosure documents such as prospectuses and private placement memorandums is like reading the cricket story extract above.

They can hear or read the words, but the words don’t have any meaning.


The Accelerant roster of securities experts with complex investment backgrounds includes:

Steve Pomerantz, Ph.D.Tom Boczar, Esq., CFATom Brakke, CFAGerry Guild, CFA, and John Duval, Sr.

You can find the complete roster here.



[1]                 Wikiquote, Albert Einstein;  Attributed by Leo Mattersdorf.  Available at  Accessed February 4, 2014.

[2]                 Fisher, D. and Frey, N. (2009). Background knowledge:  The missing piece of the comprehension puzzle.  Portsmouth, NH. Heinemann.

[3]                 Stahl, S. A., Hare, V. C., Sinatra, R., and Gregory, J. F. (1991). Defining the role of prior knowledge and vocabulary in reading comprehension:  The retiring of number 41. Journal of Reading Behavior, 23, 487-508.

[4]                 New York Times, Mets Win an Opener Light of Fans and Runs, 5/27/13, by Andrew Keh.  Available at, accessed May 28, 2013.

[5]                 ESPNcricinfo by George Dobell.  5/27/13.  “Swann Leaves New Zealand on Brink of Defeat”.  Available at Accessed 5/28/13.






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