Financial literacy’s effect on financial risk tolerance : A quantitative study on whether financial literacy has an increasing or decreasing impact on financial risk tolerance

Abstract: As of today, our perception is that there has been an increased focus put on personal financial management, such as managing your own savings and retirement planning. By way of example, the Swedish pension system is a tool that has been implemented in order to incentivize Swedish citizens to manage their capital put aside for their retirement, as well for increasing financial risk tolerance and financial literacy. In fact, financial risk tolerance is a subject that has been extensively explored more or less globally, where predictors such as age, gender, marital status, education and wealth has been proved to affect financial risk tolerance. More importantly, financial literacy is one variable that has not been receiving enough attention in light of financial risk tolerance.   With this in mind, our objective is to investigate the relationship between financial risk tolerance and financial literacy. More specifically, how financial literacy affects financial risk tolerance. In addition, we aim shed light on underlying predictors of financial literacy, such as the distinction between how financial literacy derived from formal education and stock market experience affects financial risk tolerance. Therefore we will attempt to answer the following research question:   Do individuals differ in financial risk tolerance due to their level of financial literacy?   The theoretical point of reference of this study will have its central foundation in preceding studies on financial risk tolerance, however some established theories that will be used are risk aversion and overconfidence. With regards to the practical method of this study, this is a quantitative study, where we use an established questionnaire developed by Grable and Lytton (1999). The survey is distributed at Umeå University, where the aim is to obtain a sample containing both students with an economic and non-economic background.    Finally, the results of this study reveals that financial literacy, regardless of academic background, has an increasing effect on financial risk tolerance. In other words, an increase in financial literacy implies an increase in financial risk tolerance. In addition, we also find evidence that points to the fact that individuals that rely on their intuition rather than financial literacy when facing financial risks, are more inclined to display higher financial risk tolerance. Even more, our study exhibits evidence on the fact that having stock market experience, rather than having a formal economic background, showed an increased impact on financial risk tolerance.