IMPACT OF FINANCIAL LITERACY ON FINANCIAL DECISION MAKING-A STUDY WITH REFERENCE TO RETAIL INVESTORS IN CHENNAI PDF

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com IMPACT OF FINANCIAL LITERACY ON FINANCIAL DECISION MAKING- A STUDY WITH REFERENCE TO RETAIL INVEST...

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

IMPACT OF FINANCIAL LITERACY ON FINANCIAL DECISION MAKING- A STUDY WITH REFERENCE TO RETAIL INVESTORS IN CHENNAI SHYAM PRASAD. R B.COM, MBA, ACMA, CGMA, ACCA, CWA(I). FREELANCE PROFESSOR FOR ACMA, ACCA.

NATARAJ B LECTURER, GREAT LAKES INSTITUTE OF MANAGEMENT, CHENNAI.

ABSTRACT: The knowledge about financial products is essential to choose optimal portfolio of investment. Basic understanding of financial products is required to makefinancial decisions. Financially literate people can make well informed financial decisions over several investment options. There are various factors which influence an investor to invest in a selected assets over plethora of assets in today’s world. This studyattempts to find out whether investors are having basic understanding of financial concepts and its effect on their investment choices. It also analyzes how individual investors view inflation as a factor affecting decision making or do they consider it at all. The study makes an attempt to find whether investors consider the historical data while choosing their financial assets. A well-structured questionnaire was constructed to collect primary data andthe survey was conducted among 423 sample respondents in Chennai. In this study the investors were divided in to four categories based on their understanding about the financial concepts and how they apply those concepts in financial decision making. It was found that only 11% of the sample respondents follow rational decision making process that is they consider historical data while making financial decisions and were classified under financially literacy Level IV. The findings have direct and indirect implication both in academics, retail investors and also the policy makers. The need for financial literacy is clear from this study. KEY WORDS: Financial Literacy, Financial Decision Making, Behavioral Finance,Retail Investors.

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

Introduction Financial decision making behavior has potentially far reaching effects on society. For example, the euphoria and negative aftermath in the benefit fund and chit companies in late 1990s, the fly by night IPO companies, US dot com company mania, US subprime crisis are partly attributable to poor household decision making. Even though the issue is of great importance, our understanding about the how the suboptimal financial decisions and the causes of it were limited. (Summit Agarwal 2013). There are several research carried on inflation and its effect on investments, these research were primarily for corporate investors. The reason for many research carried on for corporate investors is because the inflation rate affects the weighted average cost of capital, which in turn being used for Net Present Value(NPV) analysis. NPV helps corporates to either invest or reject a project based upon the excess discounted cashflow the project is able to generate. If a company wrongly estimates inflation and their WACC, this will lead the business to choose making projects or reject profitable projects. Either way the company will lose its shareholder value as the projects are incorrectly selected. There are also several research carried on the factors affecting the investment choices. These researchers have found out the factors which the investor feels important or how they perceive the importance of each factor. This research paper has found a niche among the previous papers as there was a clear lack of research among individual investors and the inflation as a single factor. The paper has been designed in order to probe into the mindset of the respondents to identify if they are really aware on inflation and use it subconsciously in their investment decision making process. The research study classified the individuals into four categories 

Literacy Level I : Those who are not aware of inflation,



Literacy Level II:Those who are aware of inflation but do not know that it has an impact investment decisions and Return on Investment (ROI)

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com



Literacy Level III: Those who are aware of inflation and know that it has an impact on investment decision and ROI but are unaware about the assets that provides the best inflation hedge.



Literacy Level IV: Those who are aware of inflation and know that it has an impact on investments decisions and ROI and also aware about the asset that provides the best inflation hedge.

Inorder to know which asset is the best inflation hedge data was collected for the past 15 years, inflation WPI & CPI, the aggregated average price of Land, Gold & Silver, Equity Shares, Mutual Fund, Bank & Post Office Depositsand Chit funds. The survey data crossverified with the historical price data, this will let us know if the 4th category of investors have made wise choice or they have been misguided in their wrong assessment of the asset for best inflation hedge. Objectives: The primary objective of this study is 

To analyze the impact of financial literacy on financial decision making.



To analyze the impact of demographic factors on financial literacy.



To analyze the impact of demographic factors on financial decision making.

Research Hypothesis H1: There is a direct positive relationship between financial literacy and investment decision H2: Investors with different levels of financial literacy makes varied inflation adjusted decisions. Review of literature Financial Litreacy & its implication Sumit & Mazumder (2013) study the effects of cognitive abilities in two sets of casewith regard to consumer financial decisions. They found that respondents (consumers) having higher test scores, and that to with high math scores, are substantially less likely to commit a financial mistake. 73

International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

Gartner and Todd (2005), studied that people who have low financial litreacy have higherunpaid credit card balances even though cheaper credit is available elsewhere. Financial Litreacy & numerical ability Lusardi and Mitchell (2006), found 18 percent of respondents did not understand the concept of compounding. As it was evident through a question in which the researchers had asked thwe respondents wheather a account holding $100 and earning 20 percent compound interest annually would become more than $200 after five years. Researcheres found that respondents believed the account would hold exactly $200, signifying they did not understand the concept of compounding. Lusardi and Mitchell (2007) found in the Rand American Life Panel (ALP) research that, 25% of educated and high-earning middle-aged adult respondents, were unable to answer a tougher compound interest question. In 2004 HRS research Lusardi and Mitchell posed a simple interest rate question from a threequestion financial literacy module, for this question the respondents gave an correct responses, hence it is clear that respondents ubderstand simple interest but nit compounding interest. Stango and Zinman (2007) in their research found that people who borrow more and accumulate less wealth are those who cannot properlycompute interest rates given a flow of outflows,. Financial Litreacy & age Lusardi and Mitchell, (2007) researched that knowledgeof interest rates and compounding is weakly associatedwith age. Lusardi, Mitchell, and Curto (2009) found that respondents who were aged 20 & respondents who were aged 50, with same demographics, gave similar response. Hence age & financial litreacy are not correlated Financial Literacy and Financial Planning: Evidence from India Sumit Agarwal (2010), repeats the three questions, of Lusardi and Mitchell (2006) except for the currency units and area, India. The three modified questions: The researchers found that the respondents who answered all the three financial litreacy questions correctly were male, and that 74

International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

respondents correct answer(s) increased with education level and the aggressiveness of the respondent as an investor. Research Methodology: Descriptive research is being followed and snowball sampling method is used for the study. 600 questions were collected from the sample respondents and out of which only 423 questionnaires were usable with an effective collection rate of 70.5%. Analysis: Table 1: Showing Demographic Variables of the sample respondents Demographic Variables

Frequency

Percentage

Gender

Male

291

68.79%

Female

132

31.21%

Total

423

100%

Not Attended School

106

25.06%

School

93

21.99%

Under Graduate

104

24.59%

Post Graduate

69

16.31%

Above Post Graduation

51

12.06%

423

100%

Private Sector Employee

79

18.68%

Public Sector Employee

84

19.86%

Retired from Services

75

17.73%

Self Employed/ Business

104

24.59%

Others

81

19.15%

423

100%

Below 3 Lakhs

135

31.91%

3 to 5 lakhs per annum

133

31.44%

5 to 10 Lakhs per annum

108

25.53%

Above 10 lakhs per annum

47

11.11%

Total

423

100%

Education

Occupation

Annual Income

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

The financial literacy was measured using basic financial concepts. The questions related to financial awareness and financial decision making were used to classify the sample respondents in four different levels. It was found that almost 50% of the sample respondents were classified under Level I category. There is a considerable number of peope who are still not aware of inflation. Only 10% of the sample respondents are making financial decision, considering financial concepts and historical data. Table 2: Showing the Literacy Level Classification Financial Literacy Levels

Frequency Percentage

Level I

215

50.83%

Level II

62

14.66%

Level III

100

23.64%

Level IV

46

10.87%

423

100.00%

Total 

Literacy Level I : Those who are not aware of inflation,



Literacy Level II: Those who are aware of inflation but do not know that it has an impact investment decisions and Return on Investment (ROI)



Literacy Level III: Those who are aware of inflation and know that it has an impact on investment decision and ROI but are unaware about the assets that provides the best inflation hedge.



Literacy Level IV: Those who are aware of inflation and know that it has an impact on investments decisions and ROI and also aware about the asset that provides the best inflation hedge.

To analyze the impact of financial literacy on financial decision making, correlation test was conducted. The results of Pearson’s correlation test is shown below.

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

Table 3: Showing Correlation results of financial literacy and financial decision making. Correlation Financial Decision Making

Financial Awareness

Pearson Correlation

.362**

Sig. (2-tailed)

.000

N

423

Sig. (2-tailed) N

423

**. Correlation is significant at the 0.01 level (2-tailed). The Pearson’s correlation value is 0.362 and shows that, there is a direct positive relationship between, financial literacy and financial decision making at it was found to be statistically significant at 1% level. This shows that financially literate people make conscious decision, while choosing the financial products and vice versa. To analyze the impact of demographic factors on financial literacy, Analysis of variance test is conducted for gender and educational qualification and the results of ANOVA were shown below. Table 4:ANOVA Results of Gender Vs Financial Awareness Sum of Squares Between Groups

df

Mean Square

.770

1

.770

Within Groups

616.602

421

1.465

Total

617.372

422

F

Sig. .526

.469

Table 5:ANOVA Results of Educational Qualification Vs Financial Awareness Sum of Squares

df

Mean Square

F

Sig.

Between Groups

17.106

4

4.276

2.978

.019

Within Groups

600.266

418

1.436

Total

617.372

422

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

From theANOVA results, it was found that the demographic factors gender and educational qualification when compared with financial awareness is found to be insignificant at 1% level. This shows that there is no significant difference among the financial awareness scores of male and female and also there is no significant difference among the financial awareness scores of different levels of education.

Table 6: Showing Chi Square test of Homogeneity Results of Literacy Classification Financial Literacy Levels Observed N

Expected N

Residual

Level I

215

105.8

109.3

Level II

62

105.8

-43.8

Level III

100

105.8

-5.8

Level IV

46

105.8

-59.8

Total

423 Test Statistics

Chi-Square Df Asymp. Sig.

165.038a 3 .000

The observed and expected frequency distribution with respect to different levels of financial literacy was found to be significantly different at 1% level. This shows that the financial literacy levels were not equally distributed among the sample respondents. And there is increased number of people in the Level I category that is people who are not aware of inflation.

Findings and Suggestion: It was found that, there is a direct positive relationship between, financial awareness and financial decision making.

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International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

Almost all of the demographic factors like gender, educational qualification, occupation and annual income is insignificant with respect to Financial Awareness or Financial decision making at 1% significant level.

Table 7: Showing Significance Values of Demographic Variables, Financial Awareness and Financial Decision Making. P Value Financial

Financial

Awareness

Decision Making

Gender

0.469

0.733

Education

0.019

0.049

Occupation

0.769

0.107

0.879

0.042

Annual Income

This means that the financial decision making behavior is not so different with respect to the categories of the Gender, Educational Qualification, Occupation or the annual income. With respect to education and financial awareness, the p value is 0.019 it was found to be significant at 5% level. This shows that the educated people are having some level of financial literacy also with respect to education and financial decision making, the p value was found to be 0.049, which is less than 0.05. This shows that the educated respondents can make informed financial decisions. With respect to annual income and the financial decision making, the significance value was found to be 0.042 that shows that there is difference among the annual income category and their financial decision making capability. Whereas there is a high significance with respect to financial literacy levels and financial decision making. This shows that, classification of the customers with their financial literacy levels, can provide a leading edge for the organization to device strategy according to their needs. 79

International Journal Of Marketing, Financial Services & Management Research ____________________ ISSN 2277-3622 Vol.6 (2), FEBRUARY (2017), pp. 71-81 Online available at indianresearchjournals.com

It was found that among the financial literacy level classification 50% of the sample respondents were classified as Level I, who were not aware of inflation and other basic financial concepts and a mere 10% of the sample respondents are classified under level IV, who can make inflation adjusted well informed decisions. This shows that there is an alarming need for financial awareness in the country and an extended support from the financial regulators to improve financial decision making in the country. Conclusion: Financial knowledge is very important for today’s financial policy debates. For example, Lusardi in his 2013 researchfound that when popele with financial knowledge can allocate their resources properly over their lifes. The research also found that 33% of U.S. wealth inequality can be attributed to the less financial knowledge. Kim, Maurer, and Mitchell in 2013 stated that Financial litreacy also has deep impact on the education and training policy of a country. When people make poor financial decisions, this impacts their lives, also at an aggregated level it also spells trouble for a country. Iradicating financial illiteracy has a cost, but such cost should only be seen as an investment which has an high returns. And this paper has found that fighting financial illiteracy is beneficial for the individual, society, and also the population at large. Financial products are becoming increasingly complex. Hence, people exposed to new financial risk and more complicated finan...