Chapter 2

REVIEW OF RELATED LITERATURE

This part provides articles or readings taken from various sources like books,

some researches, publication, journals, magazines, newspapers and the internet which

serve as the reference of the researchers in relation to their study on the financial

literacy as correlated to investing decision of the individual investors.

Financial literacy has in recent years gained the interest of various groups

including governments, bankers, employers, community interest groups, financial

markets, and other organizations, especially in developed countries. The importance of

improving financial literacy has increased due to factors including the development of

new financial products, the complexity of financial markets, and the changes in political,

demographic, and economic factors (Hassan, 2010).

The understanding of money and financial products that people can apply to

financial choices in order to make informed decisions about how to handle their finances

is known as financial literacy. Many individual nations have recognized the importance

of financial literacy and created task forces to study their populations with the goal of

offering education and outreach (Basu, 2011).

Financial literacy involves a number of different areas of understanding. Being

wise about money and how it works is an important aspect, as understands products

like credit, loans, and insurance. The ability to understand and work with interest and

exchange rates is also important; with interest being of particular concern since many

consumers take advantage of the credit market. Other topics of interest include
understanding risks, learning how to evaluate potential investments, and identifying

scams or dubious financial practices (Yermo, 2010).

As the world becomes more and more complex with increasing financial

products, informed decision needs to be made by every financial investor. And as

market forces continue to expand the range of providers of financial services, consumer

will have much more choices and flexibility on how to manage their financial matters.

Technologies can now be used to aid investor on how to make financial decisions in an

appropriate manner (Greenspan, 2011).

Financial knowledge is directly correlated with self-beneficial financial behavior

and so financial education should take a wholesome perspective to include the

fundamentals of finance since without understanding the basic finance principles,

pension education would be ineffective. In the words, participants who are less

financially literate are more likely to have problems with debt, are less likely to save, are

more likely to engage in high cost mortgages and are less likely to plan for retirement”

and by extension are less likely to make better choices for their investments (Kafela,

2010).

If a person has the ability to make informed judgment and to take effective action

regarding the current and future use and management of money, then, he is regarded to

be financially literate. This include the ability to understand financial choices plan for the

future ,spend wisely and manage and be ready for life events such as job loss or saving

for retirement (Madrian, 2013).

It is evident from literature that financial literacy can be taken as of mathematical

capability and the knowhow of financial wording. According to the study, financial
literacy is high for people having age of 50 and 60 years, professionals, business and

owners of farm, and university or college graduates. Literacy of financial education can

also described as the capability of individuals to go for financial decisions by keeping in

view their own best short term and long-term. It is evident that financial experience

leads towards financial knowledge creating awareness for self-education or make the

financial literacy programs more significant. Even the stock market games provide the

opportunity to gain effective exposure and experience (Frijns et al., 2014).

Salaried individuals of Himachal Pradesh were examined of their awareness

level and investment behavior of towards financial products. Researcher found out that

only 24.6% respondents had invested in pension funds, which means most of the

people do not plan for retirement which is not a very healthy sign. Also 77.7% people

had invested in life insurance which means that people are aware about the importance

of life insurance. Only 39.1% respondents invest in public provident fund. The

researcher concluded that respondents were quite aware about traditional and safe

financial products whereas awareness level of new age financial products among the

population was low. Majority of the respondents park their money in traditional and safe

investment avenues so people must be made more aware about new investment

opportunities available in the market (Puneet, 2013).

In the United State, watched the impact of Financial education on retirement

arranging regarding what degree the Americans were prepared to settle on choices in

the benefits and budgetary scene and are they adequately proficient about financial

matters and back to anticipate retirement. The examination discovered that issues with

financial literacy in which numerous respondents did not have the key learning of basic
money related ideas including enthusiasm aggravating, swelling, and hazard

enhancement; and neglected to get ready for retirement, notwithstanding when

retirement was close within reach. Respondents' absence of learning about how charge

card and premium would function is caused by obligation ignorance. Assist in the

investigation, budgetary proficiency has a negligible impact among the youthful, ladies,

and the less-instructed, more established people Lusardi and Mitchell (2011).

It is beneficial to focus on financial literacy to the society and nations. As

observed from developed countries with low financial illiteracy level, financial literacy

facilitates the decision making processes like timely bill payment, proper management

of debt, which improve the credit score of potential borrowers to support livelihoods,

enhancing economic growth, good and sound financial systems, and poverty

eradication. It also provides greater control of one’s financial future, more effective use

of financial products and services, and reduced vulnerability to overzealous retailers or

fraudulent schemes (Wachira & Kihiu, 2012).

As markets continue to place more and more financial products, individuals will,

therefore, have to decide on the many choices that comes as a result of continued

innovation and make the right choices. As human beings do not remain productive in

their entire life, since when individuals grow old, they tend to become less productive

thus depending on what was once invested. When an individual is forward looking

investment should not be an option but a necessity due to the anticipated drop in

income after retirement (Lusardi, 2008)

Hence, literacy can also be enhanced by the people who have enough resources

and utilize these resources to obtain financial information for implying better outcomes
from investment decisions. Wealthier households can spend more money to get access

to financial information. By using this information they are usually less uncertain about

the risky assets as they are aware of all the information about the financial market. As

the wealth of investor increases, his absolute risk tolerance will also increase because

he can have every type of information by using his money, but on the other hand less

wealthy individuals are uncertain because they can’t purchase that much information

(Makarov and Schornick, 2010).

To be financially literate, financial knowledge should be considered to understand

the significant financial concepts such as inflations, interest rate computation and

diversification of risk in portfolio. For one to invest wisely there is a need to be

knowledgeable in financial matters. Understanding of financial knowledge is

fundamental in deciding of whether to save or not. It has been observed that a

household that lacks basic financial knowledge, savings behavior, investment decisions

are done based on the basic rule of thumb (Musundi, 2014).

Knowledge is power and when it comes to finance it enables one to be able to

negotiate for better returns at a manageable and tolerable risk. The increase in

numeracy and the broad cognitive ability tells the level of financial knowledge which

helps predict the financial literacy of an individual. Key areas that an individual need

financial knowledge is on various concepts like credit risk and return, diversification in

the portfolio and how various computations are carried out. As observed financial

knowledge has a strong relationship with self-beneficial financial behavior (Kefala,

2010).
 To achieve optimal outcomes in this complex decision-making environment

requires decision-makers to have adequate levels of financial knowledge and skills.

Since these decisions are ongoing, requiring members to periodically monitor and

evaluate the performance of their chosen fund and investment option, and decide

whether to switch to another fund and/or investment option. The call for enhanced

financial literacy amongst consumers is a global phenomenon, driven by the growing

complexity of financial markets and products, and government concerns about the

affordability of supporting an ageing population.

It was being analyzed on the basis of these dimensions such as when it comes to

Managing Money (i.e., understanding how to budget, make informed financial decisions,

etc.) shows that 54.1 % of respondents are somewhat unknowledgeable, Personal

finance Skills have 68.9% of respondents as somewhat unknowledgeable, Financial

Saving Instruments have 61.5% of respondents as somewhat unknowledgeable,

Financial Investment Instrument have 68.1% of respondents as somewhat

unknowledgeable, Tax Saving Instruments have 44.4% of respondents as somewhat

unknowledgeable and at last Tax Planning Instruments have 68.1% of respondents as

somewhat unknowledgeable. Hence it becomes evident that the level of knowledge for

these various attributes is nearly around 45% which highlights a significant requirement

to develop the mechanism for investors to increase their level of knowledge for these

financial instruments (Reuters, 2015).

Financial behavior is another understanding of financial literacy that goes hand in

hand with financial awareness which has been observed to influence financial literacy

positively. One’s behavior in finance tends to be assessed on how well the

well as market outcomes. Seeking financial education help one to become more aware

of how to manage finances well and ends up with a happy future. Education helps to

open up one’s mind to think about possibility of a way out of any given situation. Getting

information from an expert, experienced and professional adviser is recommended,

especially to assist in well diversified portfolio management (Amos, 2014).

Behavior of investor is influenced by past experience. An experienced investor

has more tendency of selecting risky portfolio, because he gone through experiences

how to tackle it properly. Good or not better experience of investor will impact the risk

tolerance degree of investor and investment decisions. Successful past investment

experience promising towards high risk tolerances which generate high returns

evidently. So the past investment behavior is positively related with risk tolerance which

in face effect investment decisions (Chou et. al, 2010).

Individuals with proper financial behavior of saving regularly and are risk takers

do not hesitate to take up investment opportunities arising. In an examination of Nigeria

economy as impacted by savings behavior and investment made, adds that with an

increase to saving culture subsequently results to more investment which further

translate to reduced level of borrowing behavior for a country. Aggregate saving

behavior is a prerequisite for making investment decisions (Mahdzan & Tabiani, 2012).

In a study on the relation between emotions and the investment behavior

empirically, tested the behavior of 34 people in California, in which those people were

given the limited amount of money and were asked to make their investment decision

after enhancing their different emotions. The result suggested that the emotions
triggered by a given situation help the decision making process by narrowing down the

option of reaction, either by discarding those that are dangerous or by endorsing those

that are advantageous. Emotions serve an adoptive role in speeding up the decision

making process. However, depending on the circumstances, moods and emotions can

play a useful as well as disruptive role in decision making (Shiv, 2011).

Financial attitude involves the preference of one investment opportunity or

project over the other. In particular, what is the perception an individual to choose an

investment? Financial attitude refers to that state of mind or opinion and judgment about

one’s finances reflecting a position one has taken. For example, one individual in the

family may highly value children's education and hence have a very positive about

educating them as opposed to any other investment (Pankow, 2012).

Moreover is the ability to choose and invest and the preference of some

alternative over the other. It was found that financial attitude was significant predictors

of investment intentions. It was also found that risk propensity did not moderate the

relationship between the variables and the investment intentions. The findings showed

that the education in business finance can help to influence the investment decision

(Natalie, 2010).

Investment Decision

Investment is an activity that is engaged by people who have savings by commits

their funds in capital assets/ goods and services, with an expectation of some positive

rate of return. An essential element of investment is the anticipated return therefore

management of the asset invested must be done to ensure that at least assets
appreciate in value. Investment decision is the determination made by the investors, in

case of an individual investment or management where a corporation is involved, as to

how, when, where, and how much capital will be spent on investment opportunities.

These decisions are usually supported by decision tools, literacy being one of the

necessity, that would help achieve a satisfactory return after performing an investment

analysis using the fundamental and technical 6 analysis. The decision to invest is

usually followed by research to determine the costs and returns for various options

available (Pandey, 2014).

Investment decision making is a very crucial process which is influenced by

many factors. An important thing which is necessary to understand is the degree to

which an investor can absorb the risk. This intensity of risk which can be of minimal,

maximum or mediocre level, defines the strategies regarding the decisions of

investment. A determinant of investment decisions needs special consideration to be

understood by investors. This paper helps to determine those variables by constructing

a theoretical model. After studying the past researches and theories certain conclusions

are drawn whether which are the factors that impacts the decision making process

(Awais, 2015).

Investment decision making process is a critical process which depends upon

various factors that may vary among individuals. While making any types of decisions in

life people use to behave differently. Some make decision based on judgment while

others consider many other factors that direct them to act upon such appropriate

decision. The process of decision making becomes easy when all the confounding
variables are well recognized by investors. The variables which direct them to make the

right decision so that the losses can be avoided or reduced in the future (Laber, 2012).

During the period of investment decision making, investors’ encounter highly

complex factors such as risk, ambiguity, and choice overload. These are challenging for

financial professionals, experienced investors, and especially the ordinary private

households. Investors have to chase risks in their financial decisions. This can lead

them to earn profits. On the other hand any decision made by investors on the basis of

poor or misleading information or on the basis of poorly analyzed information may leads

towards imperfect outcomes. Investment as expense made now can make profits in

future (Rasheed, 2010).

Therefore to make effective investment decision, investor needs to select the

right stock among different alternatives at the right time. In order to choose superior

stock, investor has to evaluate alternative investments and specify criteria to minimize

those alternatives and rank the lifted ones. The criteria or factors that affect investment

decision could be categorized to rational or analytical factors because they have a

significant effect on decision making by pension funds managers in Kenya. Which

implies that financial literacy has a strong positive relationship with investment decision

making (Albadvi et al., 2006).

Investment decisions are vital among the many decisions that one has to make in

life for the future. It is then paramount that individuals learn about money and the way it

work. “How to be flexible in managing financial matters due to the many financial

products available for investment?”. National governments have also realized the
importance of making a contribution to saving and investment that is why so many

pension funds receive mandatory contribution and offer the contributor the option of

investing with them later in their life when they will be less productive (Hodge, 2010).

A study was conducted on the factors influencing investment decisions at the

Nairobi Stock Exchange. The study used a structured questionnaire and conducted on

the 42 investors out of 50 investors that constituted the sample size. The researcher

confirmed that there seems to be a certain degree of correlation between the factors

that behavioral finance theory and previous empirical evidence identify as the for the

average equity investor. The researcher found out that the most important factors that

influence individual investment decisions were: reputation of the firm, firm’s status in

industry, expected corporate earnings, profit and condition of statement, past

performance firms stock, price per share, feeling on the economy and expected divided

by investors (Jagongo & Mutswenje, 2014).

To achieve a good investment performance, pension trustees who are more

often than not, not investment gurus, will delegate this responsibility to professional

finance experts both fund managers or insurance companies and therefore need for 15

financial literacy. One key aspect in the management of pension funds is investment

decision. Pension trustees are in dilemmas to which way to go in investing pension on

funds to optimize returns without taking a lot of risk. The question that is frequently

asked by trustees of pension funds whether it is better to invest with fund managers or

insurance companies (Reid, 2010) .

regarding diversification, interest rates and inflation and many other economic indicators

as well. Investor’s subjective knowledge and wealth were supposed to impact their

decisions of whether to use which sources of information. Previous studies depict that

seminars, written communications and website information are good methods in

conveying financial education. So this paper will reveal that whether the financial

literacy and investment experience helps to define the risk tolerance which leads

towards making investment choices and decision (Khursheed, 2015).

Seeking professional financial advice has both monetary and non-monetary

costs. Financial advisers charge fees, commissions, or some combination of fees and

commissions for their financial services. Such fees represent a major financial cost and

have a significant effect on investment returns over a long-term horizon. In addition,

seeking financial advice has a psychological cost because individuals might need to

disclose intimate personal information and financial details in the process of discussing

their life goals and financial objectives (Hackethal et al., 2012).

As shown by a strand of both theoretical and empirical literature, seeking for an

expert can be more frequent among financially sophisticated individuals. This evidence

is not conclusive, though, as it is called into question by a few conflicting results

showing either a negative or an insignificant relationship between literacy and

propensity to ask for professional help. This evidence has prompted further

investigation. A stream of research has focused on the interaction between financial

literacy and behavioral biases. Several studies document that behavioral biases,

personal traits and framing effects may drive sub-optimal choices even by literate
individuals. In other words, knowledge alone may not be sufficient to avoid investment

mistakes, as shown also by the evidence on experts being themselves prone to

emotions and cognitive errors (Gaudecker, 2015).

Money doctors help investors make risky investments and are trusted to do so

even when their advice is costly, generic, and occasionally self-serving. Within this

model, the unadvised investor is unwilling to invest in risky assets due to “infinite

anxiety”. An investor’s anxiety is reduced through delegation to an adviser and advisers

vary in ability to achieve this. A related strand of research has documented the impact

of behavioural biases on the willingness to seek for financial advice. Several analyses

point to a significant and negative relation between overconfidence and the propensity

to seek for financial advice (Anderson et al., 2015).

Investors think of themselves as rational and logical. But when it comes to

investing, their emotional inclinations, ingrained thought patterns, financial illiteracy and

psychological biases, color how they perceive the world and how they make decisions.

Its likely most people heard their parents talking about the importance of “owning a

home”. The result is that they are more open to buying land than many other 24

investments. When you invest in real estate, you invest in something tangible. You can

look at it, feel it, drive by with your friends, point out the window, and say, “I own that”.

For some people, that’s important psychologically (Iyer & Bhaskar, 2012).

It is well accepted that decision makers are often influenced by multiple

psychological biases that distort their decision making and economic outcomes. The

study reveals that Tunisian Investors do not always act rationally while making
investment decisions. It was concluded that herding attitude, representativeness,

anchoring, loss aversion and mental accounting all influence the Tunisian investors‟

perception of their decision-making processes but there is an absence of

overconfidence bias in the Tunisian Stock Market. The study provides that people at

certain age, are less subject to psychological biases as they become more experienced

while as elder investors who are relatively less knowledgeable and have lower incomes

are subject to behavioral biases (Rekik & Boujelbene, 2013).

To conclude, there is a large body of literature that has examined how financial

literacy of people would play a role on financial decision making. These studies

concluded that financial literacy among individuals indeed made an impact on financial

behavior. For example, financial illiteracy has been considered as the reason for poor

financial practice behavior, inability to make informed financial decisions, being unable

to make personal contributions, inadequate stock participation, irresponsible financial

management behaviour, unpreparedness for post-retirement times), portfolio under

diversification, wealth accumulation poor investment decisions,financial dissatisfaction,

no intention to control personal budget , unimproved household financial management

behaviour (Aren & Aydemir, 2014).

A field study provided the evidences for the correlation between individual

decisions with financial information. The study found out that individuals which had

acquired financial education have higher discount factors than those who do not have

attained (Meier and Sprenger, 2010).

equity market participation, diversification of portfolio and the ability to avoid extreme

indebtedness (Rooij et al., 2011). Those people who possess financial literacy

commonly believe that many consumers can’t go for critical financial decisions in their

best benefits because they lack the financial education required to go for those

decisions. Financial literacy has significant effect on individual financial behaviors as it

will give favorable results (Hilgert et al., 2013).

The theoretical background on all the study’s objectives was shown and

provided, thus under the relationship between financial literacy and investment decision

such as professional service/advisor and psychological influences the chapter provides

numerous researches to show that there is a relationship between financial literacy and

investment decision mentioned above. It outlined the existing debate on the on the

relationship between financial literacy investment decision which had clarified and

proven the existence of the variables relationship.