Financial literacy and stock market participation

Abstract

Individuals a re increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. To better understand financial literacy and its relation to financial decision-making, we have devised two special modules for the DNB Household Survey. We have designed questions to measure numeracy and basic knowledge related to the working of inflation and interest rates, as well as questions to measure more advanced financial knowledge related to financial market instruments (stocks, bonds, and mutual funds). We evaluate the importance of financial literacy by studying its relation to the stock market: Are more financially knowledgeable individuals more likely to hold stocks? To assess the direction of causality, we make use of questions measuring financial knowledge before investing in the stock market. We find that, while the understanding of basic economic concepts related to inflation and interest rate compounding is far from perfect, it outperforms the limited knowledge of stocks and bonds, the concept of risk diversification, and the working of financial markets. We also find that the measurement of financial literacy is very sensitive to the wording of survey questions. This provides additional evidence for limited financial knowledge. Finally, we report evidence of an independent effect of financial literacy on stock market participation: Those who have low financial literacy are significantly less likely to invest in stocks.

The Geography of Financial Literacy

“…According to their work, these differences are particularly pronounced in rural versus urban areas. This is consistent with the evidence provided in other papers that in the absence of formal education, people acquire financial literacy via interactions with others, for example peers (Duflo andSaez 2003, 2004;Van Rooij et al 2011), and this is more likely in areas with high population density, such as urban areas.…”

“…Financial literacy questions similar to the ones used in the NFCS have been used in Mexico and Chile (Hastings and Tejeda-Ashton 2008;Hastings and Mitchell 2011;Behrman et al 2012), and similar results have been reported in India and Indonesia (Cole et al 2011). The question about bond pricing was first tested in a survey module fielded among Dutch households (Van Rooij et al 2011) and later added to the ALP (Lusardi and Mitchell 2009), and it has been shown to be very effective in differentiating between financially sophisticated and unsophisticated respondents. Across the board, these variables have been found to do a good job of characterizing peoples' levels of financial knowledge.…”

Financial Literacy and Retirement Planning in Switzerland

“…We confirm the positive relationship between financial literacy and retirement planning documented, e.g., by Bucher-Koenen and Lusardi (2011), Almenberg andSäve-Söderbergh (2011), andSekita (2011). We also confirm that financially literate households are more likely to participate in financial markets, as shown by Van Rooij et al (2011) for the Netherlands and Yoong (2011) for the United States. We confirm the results of Fornero and Monticone (2011), who find that households with a mortgage display a higher level of financial literacy.…”

“…First, following up on the studies by Gathergood (2012) and McCarthy (2011) we control for behavioral traits (risk aversion, time preferences) that may be correlated with financial literacy and that may also affect the financial behavior of households and thus their retirement planning. Second, we examine whether the observed correlation between financial literacy and retirement savings carries over to other types of financial behavior, i.e., financial market participation (as in Van Rooij et al 2011) and household borrowing (as in Lusardi and Tufano 2009;Gerardi et al 2010).…”

In Our Best Interest: Women, Financial Literacy, and Credit Card Behavior

“…For example, financial literacy has been linked to a number of important outcomes, including wealth accumulation (Stango and Zinman 2009), stock market participation (van Rooij et al 2011;Yoong 2011), and retirement planning (Lusardi and Mitchell 2008). So, the lower levels of financial literacy among women may be impeding their ability to accumulate and manage assets and, ultimately, secure a promising financial future.…”