This research investigates whether the financial literacy of individuals influences risk taking decisions and diversification behavior. This issue is relevant in that investors are increasingly in charge of their own financial security, but they have to deal with financial instruments whose increasing complexity often eventually prevents them from making conscious investment decisions. Prior empirical evidence shows that people are unable to perform a sophisticated portfolio diversification: what they do is to split equally their wealth among the asset classes available, in a naive way. We try to detect if the financial literacy is a driver of this kind of decisions. By submitting a questionnaire to 200 American individuals, we find that financial literacy plays a role in risk taking decisions, positively affecting how much risk individuals are willing to take. Moreover, only those who are literate in terms of diversification select less risky portfolios; the others merely increase their risk exposure, without managing it. Consistently with the previous literature, the strategy of diversification adopted by the literate ones is mainly naive. Instead, financial literacy turns out not being significant in explaining more sophisticated diversification strategies. As financial literacy affects positively the amount of risk taken by individuals, but only partially the diversification strategies pursued, there might be a dangerous pitfall in today's financial education programs promoted by governments and regulators, which, though they make investors more aware of their investment decisions, they eventually push them to assume more risks than they are able to manage. Two possible ways to tackle this issue could be: 1) to boost the financial literacy of the investors so as to make them able to use all the investment techniques required by the standard theory. This, however, seems difficult to obtain; 2) to promote advisory activity among investors. This may help them to apply the diversification principle in a sophisticated way.

Risk Taking, Diversification Behavior and Financial Literacy of Individual Investors

CAVEZZALI, Elisa;GARDENAL, Gloria;RIGONI, Ugo
2012-01-01

Abstract

This research investigates whether the financial literacy of individuals influences risk taking decisions and diversification behavior. This issue is relevant in that investors are increasingly in charge of their own financial security, but they have to deal with financial instruments whose increasing complexity often eventually prevents them from making conscious investment decisions. Prior empirical evidence shows that people are unable to perform a sophisticated portfolio diversification: what they do is to split equally their wealth among the asset classes available, in a naive way. We try to detect if the financial literacy is a driver of this kind of decisions. By submitting a questionnaire to 200 American individuals, we find that financial literacy plays a role in risk taking decisions, positively affecting how much risk individuals are willing to take. Moreover, only those who are literate in terms of diversification select less risky portfolios; the others merely increase their risk exposure, without managing it. Consistently with the previous literature, the strategy of diversification adopted by the literate ones is mainly naive. Instead, financial literacy turns out not being significant in explaining more sophisticated diversification strategies. As financial literacy affects positively the amount of risk taken by individuals, but only partially the diversification strategies pursued, there might be a dangerous pitfall in today's financial education programs promoted by governments and regulators, which, though they make investors more aware of their investment decisions, they eventually push them to assume more risks than they are able to manage. Two possible ways to tackle this issue could be: 1) to boost the financial literacy of the investors so as to make them able to use all the investment techniques required by the standard theory. This, however, seems difficult to obtain; 2) to promote advisory activity among investors. This may help them to apply the diversification principle in a sophisticated way.
2012
Working Paper 17/2012
File in questo prodotto:
File Dimensione Formato  
SSRN-id2162783.pdf

accesso aperto

Tipologia: Altro materiale relativo al prodotto (file audio, video, ecc.)
Licenza: Accesso gratuito (solo visione)
Dimensione 943.31 kB
Formato Adobe PDF
943.31 kB Adobe PDF Visualizza/Apri

I documenti in ARCA sono protetti da copyright e tutti i diritti sono riservati, salvo diversa indicazione.

Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10278/34493
Citazioni
  • ???jsp.display-item.citation.pmc??? ND
  • Scopus ND
  • ???jsp.display-item.citation.isi??? ND
social impact