Influence of Financial Literacy and Risk Perception on ... - Science Direct

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ScienceDirect Procedia - Social and Behavioral Sciences 235 (2016) 656 – 663

12th International Strategic Management Conference, ISMC 2016, 28-30 October 2016, Antalya, Turkey

Influence of Financial Literacy and Risk Perception on Choice of Investment Selim Arena , Asiye Nur Zenginb , a a b

Yıldız Technical University, İstanbul, 34349, Turkey Merkezi Kayıt Kuruluşu A.Ş., İstanbul, 34367, Turkey

Abstract During recent years, variables affecting the investment preferences of individual investors are an issue attracting the attention of financial researchers. In this research, we investigate variables which are affecting investment preferences of individual investors. Personality trait is not an important variable, but on the other hand our evidence shows that level of financial literacy and risk perception are important. Besides, risk perception is also affected by financial literacy and gender, but marital status is not effective at the same level. © Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license ©2016 2016The Published by Elsevier Ltd. Selection. (http://creativecommons.org/licenses/by-nc-nd/4.0/). Peer-review under responsibility of the International Management Conference Peer-review under responsibility of the organizing committee ofStrategic ISMC 2016. Keywords: Financial literacy, Risk perception, Risk appetite, Choice of investment, Bounded Rationality

1. Introduction Preferences of individual investors are not based on rational basis as conventional finance foreseen. There are many psychological, socio- cultural and environmental factors which affect investment behavior. Within this scope, Bondt et al. (2008) state that investors can not be rational, they can only have bounded rationality. Standard finance contextualizes investors as individuals who are never confused by cognitive errors and never averse to regret and who have an excellent self-control. On the other hand, according to Statman (1995), regard to behavioral finance, people are irrational, in other words they are normal. According to Baker and Nofsinger (2002) standard finance focuses on investor behavior outcomes rather than the consequences of this behavior. In place of this, behavioral finance is an emphasis on the importance of psychology in financial behavior and tries to explain the irrationality of investors. According to Statman’s description, behavioral finance is an area which is established under standard finance but offers a new perspective for standard finance’s descriptive theory. Statman (1995) states that, behavioral finance

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1877-0428 © 2016 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). Peer-review under responsibility of the organizing committee of ISMC 2016. doi:10.1016/j.sbspro.2016.11.047

Selim Aren and Asiye Nur Zengin / Procedia - Social and Behavioral Sciences 235 (2016) 656 – 663

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reflects different model of human behavior and is built by many variables like prospect theory, cognitive errors, problem of self-control ext. In Prospect Theory, Kahnemann and Tversky (1979) assert that people do not always act according to standard finance theory under risk and uncertainty and they added psychological factors and random behaviors to rational choices. ‘Prospect Theory” is a kind of revolution that brings a better description of how decisions are made under risk and it opens up new horizon in behavioral finance like Naughton said (2002). Ricciardi (2004) states that, people care about avoiding possible loss more than possible gain and under specific circumstances, sentimental and cognitive factors, which are put in action by prejudices, affect investment choices of individuals. Financial researches often investigated and tried foreseen factors that affect investment choices and risk perception. As has been stated, decision process is complicated and can not be explained by only risk-return relationship. For this reason, variables affecting the investment preferences and risk perceptions of individual investors have been investigated in this research. It is determined that investment preferences varied according to the level of financial literacy and perception of risk, on the other side personality trait is not effective. Investors who are willing to take risk are turning to equities unlike investors who prefer bank deposits. Similar results were obtained for financial literacy. Investors with a high level of financial literacy prefer equities while investors with low level of financial literacy prefer bank deposits. Besides, in consistent with the literature, advanced financial literacy is higher in man than in women. Man have a willingness to take risks more than women but marital status does not affect risk appetite. 2. Literature Review Risk is a function of profit and loss (Elmiger and Kim, 2003; Finucane et al., 2000) and contains both of them. However human perception of risk is often equated with loss. Renn (1998) highlighted the importance of the human factor in the concept of risk and he asserted that, risk is associated with how much investors are care about likely result of events occurring in the future. In this context, according to Garland (2002) risk is subjective. Hillson and Webster (2005) claimed that perception of risk is influenced by many factors, including cognitive and emotional. In a similar vein, Henrich referring to the risk perception is cognitive bias and Olsen and Cox (2001) refer to the emotional dimension of risk perception. Garling et al. (2009) indicate that the perception of risk is an important part of financial decision-making process and it is affected by many variables such as demographics and personality. However, different and conflicting results have been obtained by studies on risk perception. According to Slovic (1999), demographics is one of the most fundamental determinants of risk perception. Barber and Odean (2001) identified that men take more risks than women and similarly single men take more risk than those who are married. Regardless of the fact that men take more risks than women (Grable, 2000; Bernasek and Shwiff, 2001; Weber et al., 2002; Grable and Roszkowski, 2007; Yao et al., 2011), Hanna et al. (1998) and Friedberg and Webb (2006) could not reach the evidence of gender differences in risk perception. Chen and Volpe (2002) dealt with this issue in the framework of financial information. They state that, women have less information than man and for this reason their confidence is low and they could not take the risk. But results are also contradictory for these findings. According to Wagland’s (2009) research on Australian university students, gender is not a significant factor in financial literacy and risk-taking. Similarly kindle (2010), Joe and Grable (2004) stated that there is no connection between the genders and financial literacy. Some researchers associated investment decisions with the level of education instead of financial literacy. However, these findings also have stayed away from taking the absolute results. While Gutter and Fontes (2006), Brown and Taylor (2007) and Gilliam (2011) emphasize the importance of education factor on risky investment decisions, Masters (1989) and Yao et al. (2011) conclude that the general education level of investors is not always an effective factor.

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The studies on age which is another demographic is more consistent. Almost all researchers conclude that age is an important factor on investment decisions and youth are more tend to take risk than elders. (Hanna et al., 1998; Grable and Lytton, 1998; Agnew et al., 2003; Bellante and Gren, 2004; Tamimi and Kalli, 2009; Yao et al., 2011). The only contrary findings of this study can be found in Yang (2004)’s research. Yang stated that age is not an important factor on risk perception. Also, numerous studies investigating the relationship between marital status and perception of risk have been made. Generally, these studies support Barber and Odean’s (2001) research findings especially which indicates that single tend to take more risks than those who are married (Roszkowski et al., 1993; Sung and Hanna, 1996; Grable, 2000; Yao and Hanna, 2005; Faff et al., 2008). However, it appears that relatively few studies have not supported this finding (Haliassos and Bertaut, 1995; Hallahan et al., 2003). According to Agnew et al. (2003), marital status has affect on investment decisions yet he stated that married investors are demonstrating more aggressive investment behavior than single investors and they are more willing to take risk than others. Nevertheless Cooper et al. (2014) stressed that it is still unclear how to define the risk tolerance level, studies examining the relationship between level of risk tolerance, financial literacy and investment decisions are still conducted. Masters (1989) has shown that, if individuals’ information about investment increases, risk-taking requests is also increasing at the same time. Also Hallahan et al. (2003) have revealed the relationship between risk tolerance level and financial literacy and education. In a similar vein, Guiso and Japelli’s (2009) research on Portuguese individual investors has shown that investor behavior and financial literacy is linked in the context of portfolio diversification. By running a research on Sweden university students, Sjöberg and Engelberg (2009) found that students who are financial literate are tend to take more risk than others. Also Yao et al. (2011) stated that there will be a significant difference between financial literacy and risk perception. Bucher-Koenen and Ziegelmeyer (2011) assert that families with low levels of financial literacy can not trade in risky markets. 3. Methodology 3.1. Research Goal The purpose of this study is to investigate the impact of financial literacy and general risk perception on financial investment preferences which is theoretically discussed in the literature of Behavioral Finance. 3.2. Variables To measure personality, we used traits ten-point one-dimensional type A behavior pattern scale (5 point likert scale) which is developed by Mudrack (1999) For risk appetite, we used Pasewark and Riley (2010)’s fourteen questions and one-dimensional scale and again adopted 5 point likert scale. To measure financial literacy, twodimensional (simple and advanced) scale was used which is developed by Rooji and Lusardi (2011).Investment choices as dependent variable is measured by one question that presents portfolio, deposits, foreign exchange and equity alternatives. In addition to these variables as gender, age, education and marital status consisting of demographic questions were also asked. Table 1. Survey Items Variables

Source

Items

Personality

Mudrack (1999)

10

Risk

Pasewark and Riley (2010)

14

Financial literacy

Rooji and Lusardi (2011).

16

Investment choices

1


659

3.3. Data And Sampling Data were collected with the survey method (collected via e-mail and in person) from 94 respondents who are living in İstanbul and participate as volunteers in the study. Of the subjects surveyed, 53% are male, 47% are female. 47% are married and 53% are single. 80% is in the age group 40 years and under. Approximately 70% are university graduates and the others are the individuals who have Master's or PhD degree. As it is observed easily, sample consists of university-educated young population. Besides gender and marital status are distributed as approximately half. 3.4. Scale Validity and Reliability Because level of financial literacy is measured by number of correct answers given to the related questions, the remaining questions about personality traits and risk perception scales were collectively subjected to factor analysis. Relevant variables were translated to Turkish from original language. For this reason, explanatory factor analysis is preferred. After explanatory factor analysis, reliability analyses were made and both analysis results are presented in the following table. Table 2. Factor and Reliability Analyses Risk Perception

Factor and Reliability Analyses

Personality trait

I1

K3

I3

K7

I5

K8

I6

K9

I7

K10

I8 I9 I10 I11 I13 I14 % Variance Cronbach's Alpha KMO Bartlett's Test of Sphericity

30,319 0,894

14,186 0,824

0,768 1176,379 (0,000 significant margin of error)

As can be seen from the table, Barlett test value, which is a measure of the suitability of the variables for the main mass, was significant in the margin of error 0,000. Similarly KMO (Kaiser Meyer Olkin) test value which is test for sampling adequacy, is well above of acceptable level of 0,60. From this point forth, it is concluded that the sample is adequate and factor analysis can be done for variables. After factor analysis, reliability analyses were made and factor of five substances for risk perception and factor of eleven substances for personality trait were obtained. Each factor's Cronbach's Alpha values were above 0.80 and it is pretty good. 3.5. Analysis and Findings With the aim to investigate whether investment choices differentiate by related variables, one way anova test and then Duncan test were conducted. The results of the analysis are reported in the following tables Table 3. Anova Test Results F

Significance

Risk

Variables

3,901

0,011

Personality

0,457

0,713

Simple Financial Literacy

3,532

0,018

Advanced Financial Literacy

12,322

0,000

660


When the table 2 is examined, it is seen that investment choices differentiate according to risk, simple level of financial literacy and advanced level of financial literacy, gender and level of education. Duncan tests were carried out to detect this difference. Table 4. Duncan Test Results for Risk Investment

1

Equity Foreign Currency Portfolio Deposit

Subset for alpha = 0,05 2

3,15 3,57 3,57 Sig.

1


3

3,15 3,57 3,57 4,00 0,152

0,159

3,57 3,57 1,000

0,992

4,000 1,00

When the table is analyzed, it can be observed that two sub-groups are formed in a margin of error at 0.05 and portfolio choice and currency are accessible to both groups. When the margin of error raised for the separation of these two groups, it is apparent that these two groups are separate sub-groups. Considered in this context, it can be seen that investors whose level of risk aversion is the least (risk appetite is high) tend to invest in equities, investors whose level of risk aversion is intermediate prefer currency and portfolio investments and investors whose level of risk aversion is low prefer deposits. Table 5. Duncan Test Results for Simple Financial Literacy Subset for alpha = 0,05 Investment

1

2


2

Equity

2,97

Foreign Currency

3,50

3,50

3,50

Portfolio

3,80

3,80

3,80

Deposit

4,17 Sig.

0,118

3

2,97

0,211

4,17 1,000

0,554

1,000

According the analyze results, a clear difference is observed between who prefer equity investments and deposits in the margin of error at 0.05. While investors whose level of financial literacy is low prefer deposits, individuals’ higher levels of financial literacy are turning into equities. Individuals, whose financial literacy slightly higher than individuals who are directed to deposit investment, tend to take foreign currency and individuals who have highest level of financial literacy, prefer portfolio. Table 6. Duncan Test Results for Simple Financial Literacy Subset for alpha = 0,05 Investment

1

Equity

4,25

Foreign Currency

4,48

Portfolio

2

3

6,84

Deposit

9,00 Sig.

0,800

1,000

1,000

Similar results were obtained for advanced level of financial literacy. Investors who belong to the lowest level of advanced financial literacy prefer deposits and currency, ones who belong to intermediate level of knowledge prefer creating portfolio and investors whose level of financial literacy is highest dramatically tend to have equity in the margin of error at 0.05. In addition to these analyzes, consistent with the literature, it was examined that whether levels of financial literacy have changed according to marital status and individuals risk perception. For this, independent sample t tests were conducted.


Table 7. T Test Results for Sex and Marital Status Variables

Sex Male Female Male Female Male Female Male Female

Simple Financial Literacy Advanced Financial Literacy Risk Appetite Risk Appetite

Average 3,70 3,39 6,90 5,00 3,38 4,04 3,81 3,57

t Test 1,226 3,828* -5,180* 4,408

* 0,000 significant margin of error

Basic level of financial literacy doesn’t change by gender. But at the advanced level of financial literacy there is significant difference between man and women. Advanced financial literacy levels among men is higher than women. Risk appetite also varies by gender. Man are more willing to take risk than women. On the contrary, there is no significant difference between married and single individual’s risk appetite. To examine this finding, we researched whether there is a differentiation in the risk appetite between married and unmarried men and married and unmarried women. For this research One Way Anova and Duncan test methods were used. Table 8. Duncan Test Results for Advanced Financial Literacy Subset for alpha = 0,05 Investment

1

Single Male

3,31

Married Male

3,43

Single Female

2

3

3,86

Married Female

4,23 Sig.

0,531

1,000

1,000

Man are more tend to take risk and their marital status affects their risk appetite. For women it is observed that singles are prone to take risks a bit more than married couples. 4. Conclusion In this study we investigated whether the level of financial literacy, personality characteristics and risk perception are effective on individuals’ investment preferences consisting of deposits, foreign exchange, equities and portfolio. Within this scope One Way Anova analysis and Duncan tests were conducted. There is no a relationship between personality traits with hand the choice of investment. On the contrary, risk perception and level of financial literacy affect individuals’ investment preferences. While risk averse investors are tend to having deposit, investors with a high propensity to take risks prefer respectively foreign exchange, equity and portfolio. Significant relationship between financial literacy and investment preferences has been identified. Considering simple level of financial literacy as well as advanced level of financial literacy, if investors’ level of financial literacy is low, they prefer deposit and foreign currency. On the other hand when financial level of literacy increases, investors tend to create a portfolio or purchase equity. According to the profile of the examined respondents, financial literacy does not change according to gender at the basic level. However, it was determined that advanced financial literacy was more in man than in women. Similarly men tend to take more risk than women. However marital status does not alone affect risk appetite. But we conclude that single women are more tend to take risk than married women.

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