FINANCIAL LITERACY AND INVESTMENT DECISONS
IN KENYA: A CASE OF INDIVIDUAL INVESTORS IN
THE NAIROBI SECURITIES EXCHANGE
BY
MOHAMED ABDULKARIM MAHFUDH
UNITED STATES INTERNATIONAL UNIVERSITY
FALL 2014
FINANCIAL LITERACY AND INVESTMENT DECISONS
IN KENYA: A CASE OF INDIVIDUAL INVESTORS IN
THE NAIROBI SECURITIES EXCHANGE
BY
MOHAMEDABDULKARIM MAHFUDH
A Project Report Submitted to the Chandaria School of Business in
Partial Fulfillment of the Requirement for the Degree of Masters in
Business Administration (MBA)
UNITED STATES INTERNATIONAL UNIVERSITY
FALL 2014
STUDENTS DECLARATION
I the undersigned, declare that this is my original work and has not been submitted to any
other college, institution or university other than the United states International University
in Nairobi for academic credit.
Signed: ______________________________ Date__________________________
Mohamed Mahfudh (ID: 634935)
The project report has been presented for examination with my approval as the appointed
supervisor.
Signed: ______________________________
Date: _______________________
Samuel Wainaina
Signed: ______________________________
DEAN, Chandaria School of Business
ii
Date__________________________
COPYRIGHT
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior written permission of United
States International University.
iii
ABSTRACT
The purpose of the study was to investigate the effects of financial literacy levels of
Kenyan investors on investment decisions in the Nairobi Securities Exchange. The
specific objectives of the study were; to investigate the relationship between financial
literacy and key demographic factors such as age, income, occupation and gender to
investigate the relationship between financial literacy and financial education, and to
investigate the relationship between levels of financial literacy and investment decisions
at the NSE (Nairobi Securities Exchange).
To achieve the purpose of the study a descriptive study approach was used by the
researcher, which focused on a population of 1.9 million individual investors in Kenya
and the sampling frame used was the CDSC register of all individual investors in the
NSE. The convenience sampling technique was used and a sample size of 360
respondents was then drawn from the population which included individual investors
from Nairobi and primary data was collected using structured questionnaires. Once the
data was collected, the researcher carried out analysis using descriptive and inferential
statistics; percentages, frequencies, means and chi-square tests using SPSS and also made
use of a financial literacy model which helped in answering all three objectives. The
study results were then presented in tables, pie charts and graphs.
From the research it was evident that financial literacy levels have a significant
relationship with income and occupation of the individual local investors but do not affect
gender and age of the investors. The study also established that financial education and
investment decisions such as investing in portfolios, consulting financial analysts, choice
of investment vehicle and frequency of participation in the NSE have a significant
relationship with financial literacy. From the findings of the study, it was concluded that a
large proportion of Kenyan local investors were financially illiterate and this affected
their decision making negatively in the NSE.
The study recommends that in order to achieve higher levels of financial literacy among
Kenyan local investors, employers should conduct financial seminars to create awareness
among its employees, the government should instill financial courses as part of the
curriculum in schools to improve financial literacy levels. The study further recommends
iv
that before individual investors are allowed to participate in the NSE, they should be
advised to take part in a short financial literacy course on securities and hedging
techniques. This would raise literacy levels in the investors, and they would make better
decisions in investing such as consulting, using portfolios etc. All these initiatives will
propel the country forward economically and provide a nurturing environment for
potential investors.
v
ACKNOWLEDGEMENT
I would like to acknowledge my family, friends and the USIU community for their
motivation which enabled me to complete my MBA successfully. I am also extremely
grateful for the support given to me by my supervisor, Mr. Samuel Wainaina who has
made it possible for me to complete my project.
vi
DEDICATION
This research study is dedicated to my parents, Mr. Abdulkarim Mahfoudh Al-Ammar
and Mrs. Maimuna Jumaan Al-Mhindan without whom I would not be alive today.
vii
TABLE OF CONTENTS
STUDENTS DECLARATION ........................................................................................ II
COPYRIGHT .................................................................................................................. III
ABSTRACT .................................................................................................................... IV
ACKNOWLEDGEMENT ............................................................................................. VI
DEDICATION ............................................................................................................... VII
LIST OF FIGURES ........................................................................................................ XI
LIST OF ABBREVIATIONS ....................................................................................... XII
CHAPTER 1 ....................................................................................................................... 1
1.0 INTRODUCTION....................................................................................................1
1.1 Background ................................................................................................................1
1.2 Statement of the Problem ...........................................................................................5
1.3 General Objective ......................................................................................................6
1.4 Specific Objectives ....................................................................................................6
1.5 Significance of the Study ...........................................................................................6
1.6 Scope of the Study .....................................................................................................7
1.7 Definition of Terms....................................................................................................8
1.8 Chapter Summary ......................................................................................................8
CHAPTER 2 ..................................................................................................................... 10
2.0 LITERATURE REVIEW .....................................................................................10
2.1 Introduction ..............................................................................................................10
2.2 Relationship between Financial literacy and Demographic Factors ........................10
2.3 Relationship between Financial Literacy and Financial Education .........................14
2.4 Relationship between Financial Literacy Levels and Investment Decisions in the
NSE ................................................................................................................................20
2.5 Chapter Summary ....................................................................................................27
CHAPTER 3 ..................................................................................................................... 28
3.0 RESEARCH METHODOLOGY .........................................................................28
3.1 Introduction ..............................................................................................................28
viii
3.2 Research Design.......................................................................................................28
3.3 Population and Sampling Design .............................................................................28
3.4 Data Collection Methods .........................................................................................30
3.5 Research Procedures ................................................................................................30
3.6 Data Analysis Methods ............................................................................................31
3.7 Chapter Summary ....................................................................................................31
CHAPTER 4 ..................................................................................................................... 33
4.0 RESULTS AND FINDINGS .................................................................................33
4.1 Introduction ..............................................................................................................33
4.2. Demographic Analysis ............................................................................................33
4.3. Relationship between Financial literacy and Demographic Factors .......................37
4.4. Relationship between Financial Literacy and Financial Education ........................44
4.5. The Relationship between Levels of Financial Literacy and Investment Decisions
in the NSE ......................................................................................................................46
4.6. Chapter Summary ...................................................................................................51
CHAPTER 5 ..................................................................................................................... 52
5.0 DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS ........................ 52
5.1 Introduction ..............................................................................................................52
5.2 Summary ..................................................................................................................52
5.3 Discussion ................................................................................................................53
5.4 Conclusion ...............................................................................................................57
5.5 Recommendation .....................................................................................................58
REFERENCES ................................................................................................................ 60
APPENDICS .................................................................................................................... 69
APPENDIX 1- INTRODUCTION LETTER ................................................................ 69
APPENDIX 2- QUIZ ....................................................................................................... 70
APPENDIX 3- QUestionnaire ........................................................................................ 75
ix
LIST OF TABLES
Table 4.1: Analysis of Response…………………………………………………………32
Table 4.2: Performance of the Respondents on the Financial Literacy Quiz…………….37
Table 4.3: Chi-square Test between Financial literacy against Gender Categories…….. 68
Table 4.4: Chi-square Test between Financial literacy against Age Categories………... 68
Table 4.5: Chi-square Test between Financial literacy against
Occupation Categories……………………………………………………….. 69
Table4.6: Chi-square Test between Financial literacy against Income categories……....69
Table 4.7: Chi-square Test between Financial literacy against Financial Education.........70
Table 4.8: Chi-square Test between Financial literacy against Consultation………........70
Table 4.9: Chi-square Test between Financial literacy against Portfolio Usage…….…...71
Table 5.0: Chi-square Test between Financial literacy against Frequency of
Participation in the NSE…………………………………...………………….71
Table 5.1: Chi-square Test between Financial literacy against Preferred
Investment Tool in the NSE……………………………………………..........72
x
LIST OF FIGURES
Figure 2.1: The Investment Process……………………………………………………...22
Figure 4.1: Age Distribution of Respondents………………………………………….....33
Figure 4.2: Occupation of the Respondents………………………………………….......33
Figure 4.3: Income Distribution of Respondents…………………………………….......34
Figure 4.4: Level of Education of the Respondents………………………………….......35
Figure 4.5: Field of Study of the Respondents……………………………………….......35
Figure 4.6: Sources of Financial Education………………………………………….... ..36
Figure 4.7: General Performance on the Financial Literacy Test…………………….... .38
Figure 4.8: Relationship between Financial Literacy and Gender…………………….....39
Figure 4.9: Relationship between Financial literacy and Age……………………….... ...40
Figure 4.10: Relationship between Financial literacy and Occupation………………......41
Figure 4.11: Relationship between Financial literacy and Income………………………42
Figure 4.12: Relationship between Financial literacy and Financial Education………... 43
Figure 4.13: Relationship between Financial literacy and Consultation……………...... 44
Figure 4.14: Relationship between Financial Literacy and Portfolio Usage………….. ...45
Figure 4.15: Relationship between Financial Literacy and Frequency of
Participation in the Nairobi Securities Exchange………………………...... 46
Figure 4.16: Respondents Preferred Investment Tool…………………………….……. 47
xi
LIST OF ABBREVIATIONS
CDSC- Central Depository and Settlement Corporation.
NSE- Nairobi Securities Exchange
FISD- Financial Information Services Division
SIIA-Software and Information Industry Association
xii
CHAPTER 1
1.0 INTRODUCTION
1.1 Background
The financial systems complexity in today’s world has been brought about by their
speedy growth and sophistication (Hilgert and Hogarth, 2002). The technological
environment in which businesses are conducted has been changing by the minute every
day. The financial products and services available today in different financial markets
across the world, have increased in number and marketing them has become a big
problem (Greenspan, 2005).
The understanding of financial market products, from their benefits to their risky nature
so as to make better investment choices can be defined as financial literacy (Seth et al,
2010).
Individuals have become increasingly active in financial markets; recently financial
market participation is on a high, this is because of the promotion and introduction of new
financial products and services in the markets. However, this has brought ambiguity to
the financially illiterate investors to understand the new products and services. As a result
of market liberalization, individuals have taken more responsibility for their finances and
thus decision power has been stripped away from governments and employers (Maarten
et al, 2007).
Holzmann (2010) argues that there has been a strong and rising interest to improve
financial literacy (both publicly and privately). While this interest begun in high-income
countries, third world countries have also joined the fight to improve financial literacy in
their own countries. Holzman (2010) maintains that statistics have shown that financial
literacy by individuals is very low in all countries, which has led to under saving, poor
investment choices and less efficient markets. Thus, financial education has been
identified as one solution to improve financial literacy across all boundaries. Other
countries have opted to establish a national financial strategy and many others are
following suit. However, guidance and direction has to be offered to third world countries
1
to effectively set up the same strategy (Holzmann, 2010).According to Johnstone (2005),
literature and findings on financial literacy show that there are still a big number of
financially illiterate investors across the world; investors have failed to understand their
needs and which financial instruments to use. Illiteracy in Japan on financial products
such as equities and bonds for instance, is at a high of 71%. Close to 57% of the illiterate
group in Japan was found to be lacking knowledge on general financial products such as
options while 29% were specifically illiterate on pensions and insurance. Johnstone
(2005) argues 40% of the American population have ignored retirement savings. In
Australia, the time value of money for investments done by individual investors has been
a concept difficult to grasp; close to 37% of the investors have no idea how time value of
money is affecting their investments. Compound interest is well understood by 67% of
the respondents from Australia, USA and Japan. Though, when the respondents were
tested on application of compound interest, only 28% showed a good understanding of the
concept. On an encouraging note, findings have also shown that some countries have
remained aware of the key role played by financial education on financial literacy.
Moreover, financial education and awareness in these countries, has been channeled
through a variety of ways; media and press campaigns on financial education programs
through printed literature, internet etc, have been set up. A few countries remain hopeful
of establishing and implementing national strategies to channel and direct financial
education programs in their countries. Johnstone (2005) warns on duplication of financial
education programs as more become available from both public and private providers.
According to Letiwa (2012), statistics have shown that a big percentage of Kenyans in
rural areas; 51.3%, do not possess the literacy to manage their finances. It was also noted
that, mismanagement of finances has led 41% of the Kenyans in the rural areas to use
financial instruments to meet their daily needs. It is of great concern to note that 50% of
Kenyans use their savings to cover day-to-day needs rather than save for the future, while
at the same time financial status at old age remains a worry for 61% of Kenyans.
Statistics continue to show that loans have been handed to 36% of Kenyans while new
loans have been handed to 28% of the population to pay old ones. Among the habits
possessed by Kenyans, shopping is seen as an enjoyable activity with 25% of Kenyans
choosing to spend even if it is on credit. Moreover statistics show that professional
financial advice is no sought for by at least 67.3% of Kenyans, while 46% have continued
2
to receive and practice on financial advice from relatives. The statistics have clearly
shown the impact of low financial literacy levels in Kenya.
Letiwa (2012) asserts Rome wasn’t built in a day; strengthening financial management
acumen takes time. Financial management skills are a sum of financial knowledge,
diligence and constant practice. Financially literate individuals choose securities to invest
wisely, budget appropriately and plan for the future.
Financial education programs are designed and established to improve financial literacy
levels of potential investors so as they can make better financial decisions. The programs
are not sufficient for anyone to become an expert rather they help to groom investors
towards making the best decisions available in the market. Financial literacy helps the
investor to manage funds; thus preventing problems arising with financial obligations and
creditors, at the same time it aids investors on understanding financial options and seizing
new investment opportunities. Moreover, financial literacy enables the investor to
evaluate and compare between different types of investment products, the cash outlay
needed and the period of investing as it enlightens them in a way that is relevant to their
lives. As a result of the ever changing economic conditions in the world and volatility of
the market, financial literacy remains an essential survival tool that if used properly can
lead to economic growth in a country as a whole. Otherwise poor financial choices; low
financial literacy can be the stepping stone for economic downfall in a country and poor
living standards for individuals (Kefala, 2010).
Several studies have found demographic factors to have an influence on financial literacy.
In one of Worthinton’s (2004) studies on financial sophistication, individuals aged
between 50 and 60 years were found to have low financial literacy levels. Almenberg
(2011) found out that financial literacy among investors aged 35-50 years was higher
when compared to old investors(65 year olds) in Sweden. Consequently, Lusardi et al.
(2006) discovered that retirement also played a role in influencing financial literacy levels
of US baby-boomers(51-56 years) as they had very lowest financial literacy levels among
all the age groups. Cole et al. (2008) demonstrated the significance of age in explaining
financial literacy in India and Indonesia; he drew a parabola (curve) to show the
3
relationship between financial literacy and age whose peak(high financial literacy levels)
was at 40 years and 45 years in India and Indonesia respectively (Xu and Ziaa, 2012).
Gender has also been found to be a predictor of financial literacy in numerous studies that
have been done. A collection of several researchers such as Mandell (2008), Chen and
Volpe (1998) and Lusardi et al (2006, 2008) have concluded that men perform much
better on various financial literacy tests than women of the same age. Almenberg and
Säve-Söderbergh (2011) explain that women have lower financial literacy levels
compared to men because all financial decisions in the house are made by the man in
Sweden. Goldsmith and Goldsmith (1997) have explained as a result of women natural
disinterest in matters of finance in the household they usually score worse than men in
topics such as investments and personal finance.
Occupation is another demographic factor that many researchers have linked with
financial literacy. Most researches have shown occupation is a determinant of financial
literacy. Worthington (2004), demonstrated higher financial literacy levels with
Australians working in white collar jobs, while the financial literacy levels of those who
were unemployed or working in blue collar jobs was the worst. This research is one of
many that suggest type of occupation plays a major role in financial literacy levels.
Almenberg and Säve-Söderbergh (2011) concluded the same when they carried out their
research in Sweden. Moreover, Monticone (2010) asserts that the most financially literate
group in Italy was the white-collar group followed by the self employed individuals.
Furthermore, income (demographic factor) was also found to impact levels of financial
literacy. Higher income levels have been shown to be a motivating factor in improving
financial literacy levels, as individuals would seek financial knowledge to manage their
income effectively. This concept was first brought into light by Delavande et al. (2008)
and Peress (2004). Delavande et al. (2008) argued that investments and risky assets held
by an investor speak volumes on the financial literacy level of the individual investor.
Thus if an investor has invested in stocks, then his/her returns are a determinant of the
financial literacy possessed by the investor. Guiso et. al (2008), Lusardi et al (2007),
Lusardi et. al (2009), Alessie et al. (2007, 2008), all show that income plays an important
role and is a critical factor of financial literacy (Xu and Zia, 2012).
4
On the issue of financial education as a determinant of financial literacy, individuals who
had lower levels of education were deemed to have low financial literacy levels than
degree holders and graduates. Though emphasis was placed on the type of subjects and
courses learned; if they had any relation with finance. These arguments were forwarded
by Cole et al. (2008), Almenberg and Säve-Söderbergh (2011) and Alexander et al.
(1998). In addition, Mandell (2004, 2008) Worthington (2004) and Guiso and Jappelli
(2005) have provided sufficient evidence to show that, financial literacy and financial
education are significantly related at the elementary stage of education; primary level. In
his research, he concluded that study major also influenced financial literacy in a major
way.
Financial literacy has been labeled a key element in the formula for maximizing returns in
the financial markets as it improves investors’ decision making; whether to have a
portfolio, consult a professional analyst, invest in equities, bonds or both (Brown,2009).
In Kenya, equities and bonds are traded by the NSE; the best performing market in east
and central Africa. The NSE (formerly Nairobi Stock Exchange) has undergone various
changes in the past sixty years all in an effort to provide efficient trading among
investors; introduction of the ATS (Automated trading systems), implementation of the
WAN (Wide Area Network) so as to conduct trading even if you are not in Nairobi, set up
of the CHU(Complaints Handling Unit) to listen to the investors’ grievances and finally
becoming a member of the FISD and SIIA all in a bid to ensure accurate and timely
market information is passed to the investors(“History of Organization,” n.d.).
1.2 Statement of the Problem
Kenya’s financial market is getting complex, as investment opportunities increase and
become readily available in the market so does the need for an average individual investor
to understand the products and services in the market. Several institutions, financial banks
and the government are striving to satisfy the needs of individual investors through
creation of more sophisticated products and services. Thus, it’s common for an investor to
find himself/herself lost and confused on what to invest in. Consequently to survive in
such financial markets, financial literacy becomes essential and crucial. This is because;
investors have always been known to be the triggers of a financial crisis thus financial
literacy would go a long way to create sanity in the already volatile financial markets.
5
Many researches have been done extensively over the years to provide a clear picture on
how an individual investor can be successful in the financial markets. These include;
Meza et al ( 2008) on attitudes of investors affecting their investment decisions, Cole et
al (2009) on the cognitive ability influencing the investors mind in making his decisions
in the market and Brown (2009) on the factors contributing to an investor’s success.
These studies have focused only on general issues affecting an investor’s success in the
financial markets in Italy, Ukraine and the US. However there exists little literature on
how financial literacy affects investment decisions made by investors specifically in the
Kenyan financial market, it is in this context that this study was conducted primarily to
address the research gaps in local investing issues and contribute to better understanding
of individual investors’ success within the Kenyan financial market.
1.3 General Objective
The general objective was to investigate financial literacy levels of Kenyan investors and
how financial literacy affects investment decisions.
1.4 Specific Objectives
This study’s selected specific objectives to aid the collection and analysis of data were:
1.4.1
To investigate the relationship between financial literacy and key demographic
factors such as age, income, occupation and gender.
1.4.2
To investigate the relationship between financial literacy and financial education.
1.4.3 To investigate the relationship between levels of financial literacy and investment
decisions in the NSE (Nairobi Securities Exchange).
1.5 Significance of the Study
The findings of this study will provide value to the following:
1.5.1 Schools/ Learning Institutions
Financial education courses would be introduced in schools’ and other learning
institutions’ curriculum to grow a nation’s awareness to personal financial management
and public finance management. This would improve investment decisions and spur
economic growth and financial markets stability in the long run.
6
1.5.2 Nairobi Securities Exchange (NSE)
The NSE can genuinely find the answer to low NSE participation ; low financial literacy
levels among the Kenyan individual investors. Thus, aggressive efforts would be done to
create awareness on products and services in the NSE.
1.5.3 Companies, Financial Institutions
Most firms and financial institutions would opt to float financial securities such as
infrastructure bonds without conducting awareness and educative campaigns on the bonds
floated. Most of the time, funds generated are not as expected simply because the
majority of the investors are financially illiterate and do not understand the workings of
the floated bonds. Thus financial education campaigns should be staged everywhere to
promote high participation by investors.
1.5.4 Individual Investors
Individual investors would understand the impact of financial literacy on the choices they
make in the NSE, this realization would motivate them to gain more knowledge on
personal financial management and investing thus letting them take rational and
controlled decisions on their finances to boost their wealth.
1.5.5 Government
The government of Kenya will understand that the main culprit in causing instability in
financial markets is low financial literacy levels. The government can then mandate
schools and higher learning institutions to add finance courses in their curriculum to
develop a more financially literate population from a young age.
1.5.6 Researchers
This study will be a standard in promoting further research in the effectiveness of
financial literacy in affecting investment performances , also more ways can be
researched on how to improve financial literacy levels.
1.6 Scope of the Study
The study was aimed at investigating the financial literacy in Kenyan individual investors
participating in the NSE, at the same time the study would show effectiveness of using
financial education to promote financial literacy. The study made use of a sample of 400
individual investors from a population of 1,900,000 registered individual investors in
7
Kenya. Data would be collected from stock brokerage firms and also places of work
where questionnaires would be given to the respondents. The completion of the study
took a year thus due to time and financial constraints the study failed in finding out how
ethnicity, religion and socio-cultural practices influence financial literacy. Therefore
further researches are encouraged to investigate other factors that impact financial
literacy.
1.7 Definition of Terms
1.7.1 Financial literacy
The process of learning different products and services characteristics offered by any
financial market and using that knowledge to make rational informed decisions to make a
gain/profit is known as financial literacy (Seth et al., 2010).
1.7.2 Investors
Any individual who gives out a cash outlay (capital) with the hope of a financial gain in
his/her investment (Noctor et al., 1992).
1.7.3 Financial Education
The gaining of financial knowledge and literacy from specific designed courses in finance
(Noctor et al., 1992).
1.7.4 Investment Decisions
Choices made by investors on how much funds to invest, what to invest in (security),
strategies to use when investing and how long to tie their money in securities (Brown,
2009).
1.7.5 Demographic factors
A population’s social and economic factors expressed in terms of gender, age, marital
status, occupation, income, mortality, birth rates etc (Brown, 2009).
1.8 Chapter Summary
This chapter gave a brief informative background on the issue of financial literacy in the
world. It clearly outlined the purpose, research objectives and showed the existing gap the
research would fill.
8
In chapter two, a detailed literature review from different sources would present the
findings on the relationship between financial literacy and demographic factors such as
age, income occupation, gender and later financial education. Finally literature stating the
findings on the relationship between financial literacy and investment decisions made in
the NSE would also be presented.
Chapter three will provide a step by step explanation on the research design used,
population studied, sampling and finally, tools and methods of data collection and
analysis used would also be highlighted.
Chapter four will present collected data in tables and figures after analysis while chapter
five will provide discussions on findings made, draw conclusions and provide
recommendations.
9
CHAPTER 2
2.0 LITERATURE REVIEW
2.1 Introduction
This chapter will provide literature sources showing the relationship between financial
literacy and various demographic factors such as age, occupation, income and gender. It
will also show previous research findings on the relationship between financial literacy
and financial education and investment decisions made by the investors.
2.2 Relationship between Financial literacy and Demographic Factors
2.2.1 Relationship between Financial Literacy and Age
Age has been described in several researches as a determinant of financial literacy;
Worthinton (2004) concluded in his research that financial literacy levels in old people in
Australia (51-60 years old) was lower compared to young individuals (21-49 years old).
On a another study done in Sweden, Almenberg and Säve-Söderbergh (2011) observed
similar results as Worthinton in that, 65 year olds registered the lowest levels of financial
literacy than any other group while the 35-50 year old group recorded the highest levels
of financial literacy. They explained the relationship between financial literacy and age
using a curve, the curve showed financial literacy at different ages of an individual. The
curve was at its peak at around 35 years and lowest at 65 years. On a similar note, Lusardi
and Mitchell (2006) noted a five percent better performance on financial literacy test
scores with prime age group (25-65) than those under 25 or over 65 years old; U.S
retirees in the 51-56 years old age group were the least financially literate. Consequently,
research in India and Indonesia found high literacy levels were highest at 40 and 45 years
respectively (Cole et al., 2008).
Lusardi and Mitchell (2011a) cautioned that there is a need for researchers to differentiate
between different factors such as age and cohort effects while investigating the impact of
age on financial literacy in a population. They concluded at the end that, financial literacy
decayed as individuals become older. Finke et al. (2011) likewise in his research,
explained further why old age was associated with lower financial literacy levels all over
the world. They showed that lower financial literacy levels in old people was as a result
10
of cognitive processes declining at a very fast rate, thereby affecting the ability to
remember important aspects of finance. Finke et al. (2011), considered their research to
be free from cohort effects and other demographic factors. In addition, a research done by
Lusardi et al. (2009b) managed to shed new light on the issue of financial literacy and
age; they found that financial aspects such as risk hedging, inflation rates and interest
rates were only understood by less than 33 percent of American teenagers (ages 12-17)
from different races while different races performed differently when handed the same
financial literacy. The races that were attributed with lower financial literacy levels were
the Hispanics and African-Americans. Mandell (2006) supported the findings and
arguments presented by his fellow researchers; by providing evidence to show that youth
(12-22 years) financial literacy levels have been declining since the 1990’s. His research
was based on findings from high school seniors’ jump start surveys. Beal and Delpachitra
(2003), did a study on financial literacy of Australian college students picked at random
and compared their literacy to adults aged between 30-45 years, they found out that
financial literacy in the adults aged between 30-45 years was higher than that of college
students in Australia. They concluded that, the difference of financial literacy levels
between the two groups resulted from adults having more exposure to real life financial
issues than the college students.
2.2.2 Relationship between Financial Literacy and Income
Researches done over the years have shown that there is a relationship between financial
literacy and income. The relationship between the two variables can simply be explained
by understanding the causal effect of financial literacy on income and vice versa.
According to Behrman et al. (2010), there regression analysis provided clear evidence
that financial literacy leads to income growth in the US. However, Jappelli and Padula
(2011) maintained that the relationship between the two variables was evident only during
an investment lifecycle. Correlation between income and financial literacy was significant
throughout the investment period. Supporting the argument brought upon by Japelli and
Padula were Hastings and Mitchell (2011) who also confirmed the correlation between
the two variables through empirical evidence from Chile. Though their research
concluded that the most important determinant of income was not financial literacy but
impatience. Behrman et al. (2010) investigated that financial education, financial literacy
and income were all related. Income was affected by both financial education and
11
financial literacy but the variable that strongly affected income was financial literacy and
not financial education.
There also exists sufficient evidence to show the causal effect of income on financial
literacy. Numerous researches have shown that income has an impact on financial literacy
as the need for personal financial management motivates the acquisition of financial
knowledge (financial literacy). Willis et al. (2008) argue that there exists a frontier
(mean-variance) which an investor can continue to make sufficient returns on his returns
at any given risk level so long as he remains inside the frontier. The three researchers
concluded that, although any investor will have to spend (cost) on gaining financial
literacy the benefits they would obtain from higher risk- adjusted returns will be
substantial and above average. Hence, as costs rise with the financial literacy gained so do
the returns; higher levels of literacy ensure higher expected returns that will compensate
for any costs associated with gaining financial literacy. Thus, high income earners should
be highly motivated to gain financial literacy as this predicts the high levels of returns
that they would receive in their investments.
Peress’ (2004) study however, has pointed out that high income earners have much to
spend than low income earners, as such high income earners can spend more in gaining
financial literacy (information on products and services in the market) thereby branding
them risk takers or risky businessmen. It is in this regard that Peres stipulates higher costs
incurred in gaining financial literacy will raise portfolio adjusted risk and returns. Thus
tolerance to high costs of investing from the high income earners makes them suitable
candidates to expect huge returns from the markets. He cautions that while high income
earners can follow his model of high risk- high returns suitably low income earners
cannot enjoy the same priviledge as his model depicts that gaining financial knowledge
(literacy) about the market is not worth the cost for any low income earner. There exists a
threshold where any investor earning below 50 percent of the per capita income cannot
practice the model efficiently. This model has been established under the assumption that
financial literacy about the market increase portfolio risk-adjusted returns for any investor
who is above the set threshold.
12
2.2.3 Relationship between Financial Literacy and Occupation
Research has shown that occupation plays a significant role in influencing financial
literacy levels. Worthington (2004), recorded highest levels of financial literacy with
Australian professionals especially those working in white collar jobs while the lowest
levels of financial literacy were seen with unemployed individuals and those working in
blue collar jobs. His findings are similar to Almenberg and Säve-Söderbergh (2011) for
Sweden. In another study, Monticone (2010) observed very high financial literacy levels
with two groups; the white collar jobs group and self employed group. He also found that
his most illiterate group was made up of individuals working in blue collar jobs, the
unemployed and individuals working in health and tourism sectors .He explained that the
levels of financial literacy were also also dependent on which type of white collar job or
self employment an individual was involved in. For instance, he pointed out that
individuals working as accountants or working in the financial sector had very high
financial literacy levels than computer technicians or doctors. This was because,
accountants get to learn several financial aspects as they keep on doing their work. Thus
doctors and computer technicians have no high levels of financial literacy as a result of
the nature of the work they are involved in. Finally, Cole et al. (2008) argued that in
Indonesia individuals working as entrepreneurs registered high levels of financial literacy
compared to the village farmers who had lower financial literacy levels.
2.2.4 Relationship between Financial Literacy and Gender
The most important aspect of having financial literacy is the possession of market and
investment knowledge in the financial markets (Braunstein& Welch, 2002). The current
situation in the market right now warrants any investor to have a participative role as
they get exposed to different types of investment securities; this will help the investor to
stay in touch in a complex market. (Braunstein & Welch, 2002; Lusardi & Mitchell,
2007). According to various studies, men and women have had different levels of
financial literacy based on financial markets since time immemorial. In general, these
studies suggest that women have lower financial literacy levels than men as they possess
little knowledge on securities, investing and the market (Hira & Mugenda, 2000; Loibl &
Hira, 2006). The gap in financial literacy levels between men and women has been
observed at the college level in the U.S, where men have performed better than women in
structured financial literacy tests and finance courses
13
(Chen & Volpe, 1998, 2002;
Goldsmith & Goldsmith, 1997). Ford and Kent (2010), noted that the difference in
financial literacy levels between men and women is as a result of three things; women
have no interest at all in financial matters that are taking place in the financial markets,
they are also intimidated by the complexity of investing in the markets and they have no
situational awareness (they have little financial information about the markets at any
time). A collection of surveys and studies that have been done over the years in the U.S
and have supported the above arguments completely; findings have shown higher
financial literacy test scores in men than women (Mandell 2008). Cole et al. (2008) and
Worthington (2004) noticed gender based differences in Sweden on financial literacy
levels and explained that in Sweden it’s normal for women take a back seat when it
comes to making economic and financial decisions in the house. This has caused a lack of
interest in personal financial management and has led women to be disinterested in the
activities of the financial markets in the long run.
Fonseca et al. (2009), stipulates that since women have been known to live longer
scientifically and a small percentage of them have professional jobs then their low
financial literacy levels are of great concern as they would be financially vulnerable.
However, in his study, he found that the low levels of financial literacy in women can
easily be explained by looking at the relative levels of financial education between
women and men. Thus, financial education is the critical factor in explaining why men
have high levels of financial literacy. He maintains that if more women especially in third
world countries are allowed to pursue their education without hindrance, then with time
there would be no gender based differences in financial literacy levels. Lusardi and
Mitchell (2008) carried out a research in the U.S. and explained that since women are
known to survive for longer life spans, then they are in more danger of old-age poverty as
they constitute a large proportion of the financially illiterate in the U.S.
On another research, Koshal et al. (2008) did a survey on MBA students in India, and
found that financial literacy cannot be determined by gender differences.
2.3 Relationship between Financial Literacy and Financial Education
The Organization for Economic Co-operation and Development (OECD) has defined
financial education as the process by which investors in the market gain financial literacy
14
through a formal(schools, universities etc) or informal (e.g. seminars) setting to provide
them with familiarity on investment securities, risks and opportunities so that they can
make clear informative choices in their investments (Seth et al., 2012).
The relationship between financial literacy and financial education has been explained
clearly and in depth in numerous studies all over the world. Several studies have
acknowledged effectiveness of financial education while another group of researchers
have argued financial education is ineffective in improving financial literacy. Empirical
evidence exists in both cases but a majority of the researchers agree that financial
education plays a major role in improving financial literacy levels (Seth et al., 2012).
2.3.1 Effectiveness of Financial Education in improving Financial Literacy
Graig and Tversky (1995) were the first in giving solid and clear evidence that, the only
way to change misunderstandings and fear in stockholding is through financial education
which would boost the investors financial literacy to make informed and rational
decisions in the market. Their argument was supported by Luigi and Jappelli (2005) who
claimed that, there exists a strong correlation between the two variables; financial
education and financial literacy especially when the investors were dealing with stocks in
the financial markets. In addition, Campbell (2006) believed that not only does financial
education improve literacy on the products and services in the market but also it
significantly reduced the capital/entry cost in the financial markets. He showed that
improved literacy from financial education was earning Swedish investors higher returns
as a result of portfolio diversification. Other researchers such as Lusardi and Mitchell
(2006, 2008), Lusardi and Tofano (2009), Stango and Zinman(2009) argue that the most
crucial ingredient that investors normally overlook and plays a major role in the returns
the investors make is financial education.
Abreu and Mendes (2010), did a survey of Portuguese investors, and found that one of
the profound impacts of financial education to investors psychology is portfolio
diversification through improved literacy levels, his argument was supported by Guiso
and Jappelli (2009) who after studying investors’ habits and investment practices in Italy,
concluded that at least 70 percent of those who invested in portfolios had listed financial
education as a key factor of success in the financial markets.
15
Volpe et al. (2002) found that high financial literacy scores were consistent with finance
and accounting graduates than any other group of investors old investors in the US.
Moreover, Bernheim, Garret, and Maki (2001) showed that high school curriculums
yielded better investor performance in the financial markets when short finance courses
were introduced and structured in them. Savings done shot up 5 years after high school
which related to high investments and better performance in the financial markets.
Furthermore Bayer, Bernheim and Scholz (2009) also observed retirees(investors) who
attended seminars on finance (informal financial education) whom participation levels in
the financial markets increased as a result of better saving plans and continued success in
the financial markets.
In one cross-country study, Jappelli’s (2010) investigated 55 countries on how financial
education has affected the literacy levels of it’s investors and he found out that financial
literacy was high in certain investors whom took math, science and financial courses in
college. College attendance was also seen as a factor but he concluded that it was not a
strong determinant of financial literacy compared to the former. The countries’ social
security system was found to be the only hinderance to financial literacy as investors did
not get to spend on the money they saved for themselves. Thus there was no incentive to
improve financial literacy levels through education as investors did not have enough
money to participate in the financial markets.
In the same regard, Chen et al. (1996) in his research to establish financial literacy levels
of U.S. investors found that, financial literacy levels of the investors were very low.
Careful investigation revealed that financial literacy levels of those who went to college
was higher than those who didn’t while business and finance majors registered higher
literacy levels than non-business majors. Finance and accounting appeared to be the best
combination of the business majors who scored very high in the literacy test.
An evaluation done by the High School Financial Planning Program sponsored by the
National Endowment for Financial Education (NEFE) in the U.S., revealed that the
program was offered to potential investors (students looking to invest after college) and
their perception on savings and investment decision making changed significantly.
Teachers tested the students three months after they had taken the program and the
16
students understanding on products, services and investment practices improved
dramatically. The most significant change noted was that 60 percent of the students
confirmed that the program had already impacted their lives positively by instilling saving
habits so as to invest later in the financial markets (Boyce and Danes, 1998).
2.3.2 Difference of Opinion: Ineffectiveness of Financial Education in Promoting
Financial Literacy
Although several sources have that financial education is effective in improving financial
literacy levels, there still exists other sources that have questioned effectiveness of
financial education on improving financial literacy. One of the arguments against
effectiveness of financial education on improving financial literacy is argued by Heckman
(2008) who sought to explain the issue by using psychology. He argued that for financial
education to work the investor has to have either cognitive skills or the right personality
trait to compensate for lack of cognitive skills. Thus people who possess cognitive skills
can be financially educated to improve their literacy levels while those who do not
possess cognitive skills cannot. He explains that once individuals learn about their
weaknesses (in this case; lack of cognitive skills) they would boost their cognitive skills
by preparing an environment since early childhood that can promote faster cognitive
development. Hence the idea that financial education could be used on them later to
promote financial literacy levels in these cases would not yield improvements in literacy
levels as education has less effect on cognitive ability. Other researchers have supported
Heckman in questioning effectiveness of financial education in boosting financial literacy
levels for instance discontent Mandell and Klein (2009) carried out a research on high
school students in California and found that, given a certain number of high school
students who have taken a short course on financial education and a control group that
has not, the literacy levels of the students who took the course in an administered test was
found to be basically the same with the control group. Moreover, Cole and Shastry (2009)
argued that financial education included in schools’ curriculum have no effect in boosting
financial literacy levels of any individual(potential investor) should be abolished as they
make no difference in their literacy levels. This is because financial education can only
help if the individual possess’ cognitive ability to match with the new knowledge. One of
the most extensive research was done in the U.S. from 2000 to 2006 to investigate the
17
effectiveness of financial education on financial literacy levels and negative conclusions
were drawn from it about the relationship between the two. The study used Jumpstart test
scores to verify the performance of the high school students after selected high school
students in their final year were made to take a short financial education course for the
whole semester while another control group of high school seniors were excluded from
the course. The performance of the test revealed that there was no much difference
between the two groups (Mandell, 2008). Once the findings of this research were
revealed, critics argued on the reliability and validity of the research and pointed out
several issues they thought constituted as weaknesses. The critics pointed out teacher
preparation schedules, course syllabus and instrument of measurement used to measure
the performance of the test as unreliable and therefore the findings of the research were
questionable. On the course syllabus, the critics pointed out that the students were all
from different schools thus even if the finance course content stayed the same, there was
bound to be differences in understanding the material as different teachers could
emphasize different topics and thus affect level of understanding of the students. Another
issue was on the teacher training and preparation, different teachers who took different
training and preparation schedules in different schools could result in different and
inconsistent quality of teaching. Thus students would normally understand and learn the
course differently from teachers. Furthermore, the other weakness that was clearly
pointed out was the fact that, there was no way to establish if there was an improvement
in the levels of financial literacy as the test data did not take the financial literacy levels
of the students before the study was done(Atkinson et al., 2008).
The scarcity of researches to suggest effectiveness of financial education in improving
financial literacy levels does not render strong support to financial education as a way of
eradicating low financial literacy levels. Lack of robust evidence and findings has
contributed little to assert that indeed financial education is not effective in boosting
financial literacy levels. Supporters of this idea (financial education is ineffective in
promoting literacy levels) argue that most international researchers and reviews carried
out point to the fact that financial education is not effective in school settings as well as in
ad-hoc work training programs. In poor countries only a handful of valuations have been
done on effectiveness of financial education on financial literacy, but critics have argued
that even in third world countries the evidence is not substantial to conclude that financial
18
education is effective in boosting financial literacy levels. Common logic dictates that
opposing effectiveness of financial education in improving financial literacy levels
because sufficient empirical evidence does not exist does not mean that financial
education is useless in improving financial literacy across the world. It only means that
the few studies that have been conducted need to be supported by many more to pull the
debate on one side. Several issues have been identified to affect validity of the researches
done; analysis and insufficient data, measurement instruments, insufficient control groups
and little attention to quality of presentation and small attention to details that can affect
the course of the research. All this, shows that sufficient evidence is lacking to support
the impact of financial education on financial literacy levels but does not show proof that
financial education has no impact on financial literacy levels. This debate calls for caution
until sufficient evidence is available to prove whether financial education plays a major
role in improving financial literacy levels or does not. Thus at the moment more research
should be conducted to provide enough data and test techniques to help settle the debate
(Atkinson et al., 2008).
Of course, financial education may seem to be only part of the solution and not the whole
solution if capability of the investors and the potential investors is taken into account, this
is because financial education may provide the knowledge (literacy) but not the means to
execute investment decisions. Financial education may instill new knowledge in the
investor’s mind but will not change or impact the attitudes and behaviors already inside
the investor’s mind. In the third world countries for instance a negative attitude towards
financial institutions resulting from a lack of trust may arise and there would be nothing
to save the situation not even financial education. Cultural beliefs and norms may also be
deeply embedded inside the investors’ psychology and even financial education with the
most experienced of teachers will not have an impact on the investor. In such cases
outside and new interventions are required to change psychology of the investor. It is only
fair to note that financial education to some extent can play a minor role in changing the
investors’ beliefs, norms and behaviors but the investor will face more challenges in the
future as a result of his/her own perceptions of the market. For instance, regardless
whether the investor has attended many courses on personal financial management there
still exists other powerful behaviors and impediments such as procrastination, anger, fear
and temptations that can override any disciplined investors psychology and financial
19
education wouldn’t help. Psychology then, has led many researchers to try and understand
whether it is the main driver of the decisions made by the investor rather than financial
education (Meza et al., 2008).
2.4 Relationship between Financial Literacy Levels and Investment Decisions in the
NSE
2.4.1 The Investment Process
Powell (2009) maintains that, it is common knowledge that as investors our sole dream is
to gain above average returns and beat the market every now and then. Thus, we wish that
our investments are always timely, are of the right magnitude and the risks to our
investments are minimal. The investment process has always been disregarded , because
we want to read about all the strategies and philosophies of making millions and scoring
big in the financial markets but we don’t want to waste time learning the correct process
and steps towards investing. Most of us would rather focus our attention on how Warren
Buffet continues to make millions in investments in the financial market than to learn the
steps involved in protecting our investments from risk or how investing in a basket of
goods can mean the difference between success and failure in the market. As investors, it
is not surprising at all that our main focus would be directed towards investment
philosophies and strategies, and so little on the investment process and plan as a whole.
Though the investment process has always been overlooked, it is a must for every
investor who is serious about executing successful investment transactions to learn and
understand the message behind it, because of the following reasons:
First of all, the investment process is a sure way to star learning about how portfolios are
created. The steps in the investment process make it easy for anyone to understand the
need for a portfolio. The investor would start by acknowledging that risk exists in
investing and he/she has to choose his/her own risk preference for any security chosen.
Monitoring and evaluating comes after the portfolio has been created and the expected
risk and returns would be evaluated against the actual risk and returns incurred, so as to
measure the performance of the portfolio. By understanding this, the investor understands
the systematic way to the formation of a portfolio.Secondly, once an investment process
is clearly outlined in the investor’s mind, then the investor can be able to understand the
20
origin of any strategy or philosophy used in investing. For instance, if the investor were to
read on a good strategy somewhere then they can trace the roots of that strategy by just
looking at the map (investment process). Thus they can translate hundreds of different
strategies into simple steps by just learning the investment process. This would make it
easier for the investor to choose a strategy wisely.
Finally, the investment process clearly points out the most crucial steps for any
investment strategy. So before any strategy the investor uses, he has to make sure it is in
line with the crucial steps in the process of investing. Thus, captivating strategies that do
not incorporate the crucial steps of investing can easily lead to failure.
It is important to note that in the beginning, the investment process will always highlight
the most crucial of all the steps. This step is; the understanding of the investors needs and
preferences. This step forms the basis for all the other steps without which the investment
process would be reduced to an assumption game. A financial analyst cannot assume or
guess the needs and preferences of his/her client. The needs need to capture the tax status,
risk attitudes, risk preferences and average return expected together with the cash outlay
the investor is willing to spend (Powell, 2009).
Powell (2009) continues to explain that after the hardest part is out of the way, then
logically the next part/step is the putting together of a portfolio. For the sake of
understanding the process of portfolio construction, he divided the process into three
components. The first component is finding out which security class and what proportion
(allocation) of the chosen security is to be used to form the portfolio. The types of
security classes here include equities, bonds and real estates. The second component is
where the specific equity in the equity class, the specific bonds in the bonds category and
the specific real estate in the real estate category are chosen to be incorporated in the
portfolio. component he mentioned was the asset selection decision, where individual
assets are picked within each asset class to make up the investment portfolio. The final
component is execution. Simply put, putting the portfolio together and transacting. He
cautioned that this component can be the hardest as well as the easiest for different
investors. Though he point out that, so many have failed in this stage before. The final
part/step of the process; is the toughest of all. This is where results of the investments
made would be measured against the set standard by the investor. The evaluation stage is
21
the most painful and sometimes the most satisfying stage of the whole investment
process. It all comes down to how much more has your investment gained or how much
has it lost. Investing has always been about making more money, thus the result an
investor gets in this stage will enlighten him and give him more experience as he/she
looks to invest in the future and gain more money. Evaluation techniques are as important
as investing strategies as the exact picture of what an investor has lost or gained can help
make or formulate better strategies in the future (Powell, 2009).
These parts of the process are summarized in Figure 2.1
Figure 2.1: The investment Process
Source: Powell (1999)
On another note, Brown (2009) asserts that there are 3 main questions any serious
investor should seek to answer before undertaking an investment in the financial market.
22
Though the questions would clearly appear quite simple, he warns and cautions on their
importance in helping the investor set his/her priorities straight. The three main questions
any investor should ask himself or herself are the what of the investment, why of the
investment and the when of the investment.
With the what of the investment, the potential investor should find or give a definite
investment type he/she wants to undertake. The investor could choose the stock market
for instance if it’s preferable to him/her but also has to be able to choose particular
investment vehicles to invest on for example stocks and bonds. The why of the
investment, comes about in the justification of the choice of the investment, in this case
the stock market. This is where the investor evaluates and measures the risks and rewards
of the investment in the stock market and figure out ways to increase his/her returns and
gains without losing his/her cash outlay/capital if things go sour. Each investor should
make sure that, the investment chosen would reap more return than all other possible
investments channels (Brown, 2009).
In any type of investment channel, time is always an issue. The investor should be aware
for how long he/she wants to tie up his/her capital in the investment, how long he/she is
willing to withstand any complications in the market affecting his/her investment and
finally when to make the investment, in this case when to buy/purchase the stocks, bonds
etc. and when to liquidate them. With these 3 simple questions well answered, an investor
could be well rewarded in the market (Brown, 2009).
2.4.2 Relationship between Financial Literacy Levels and Financial Market
Participation
Lusardi et al. (2007) argues that the biggest shock in the financial markets is the small
number of of investors that hold stocks and participate in the market frequently. The
number of long term
investors in the financial markets today are only a handful
compared to the number of momentum investors. This means that the frequency of
market participation will continue to be lower as long as more investors opt to be
momentum investors. They maintain that in the U.S. right now, only 23.8 percent of the
investors have stayed with their stocks three years or more (long term investors).
High financial literacy levels affect stock ownership in the financial markets at the same
time leading to high and frequent market participation. Some investors with high literacy
23
levels have also been observed to take a back seat in participating in the financial
markets. This finding translates to; market participation to some extent is affected not
only by financial literacy but also with other factors such as attitudes, beliefs etc (Lusardi
et al.,2007).
Lusardi et al. (2008) confirms that there is still more to research if we are going to
understand the reason behind low market participation while at the same time keeping an
eye on the meager proportion of investors holding stocks. In his research, Lusardi and his
colleagues managed to find out that financial market participation increased with an
increase in financial literacy levels. They grouped financial literacy as basic and
advanced. They found that improvements in basic or advanced financial literacy levels
translated to an increase in the frequency of market participation. Basic financial literacy
constitutes simple calculations on returns from bonds, stock gains , inflation, time value
of money etc while advanced financial literacy covered deep calculations on risk/returns
and viability of investments done on bonds and stocks and other investment vehicles.
Data in this research was organized into quartiles, respondents on the highest quartile
were investors with very high literacy levels compared to the investors in the other
quartiles. It was no surprise to note that the investors in the highest quartile were the
leading participants in the financial markets.
The study provided a conclusive answer with regards to the relationship between financial
literacy and stock and financial market participation. The empirical evidence given
suggested a significant relationship between the two variables even after demographic
characteristics such as income and wealth have been controlled. The estimates given by
the study were sizeable and reliable as a one-standard deviation in financial literacy levels
among the investors caused the market participation to increase by eight more points
(percentage). This effect was seen to be almost similar when financial literacy was
compared against demographic factors such as income and financial education. The
small difference between the two groups of variables (market participation and
demographic factors such as income and financial education) was clear enough to suggest
that higher financial literacy levels affect investors’ market participation more than the
suggested determinants (income and financial education) of stock ownership (Lusardi et
al., 2007).
24
Several more studies have supported arguments that high financial literacy levels indeed
improve financial market participation of investors. In one of his studies, Rooij et al.
(2011) discovered the secret behind the dutch investors’ fear and shyness from
participating in the financial market especially the stock market was simply a matter of
low financial literacy about stocks and the financial markets as a whole. They insist that
basic financial literacy can be used in the right way to show the required estimates, thus
basic literacy can be used to predict stock market participation without making use of
advanced literacy. Christelis et al. (2010) confirmed the use of basic financial literacy as a
predictor of stock market as well as financial market participation among 50 year olds
from 11 different European countries. The study also made use of the respective
portfolios of the respondents and their income; the two variables were controlled in the
research.
Basic and advanced financial literacy measures have been important and have played a
major role in establishing the relationship between financial literacy and frequency of
financial market participation. According to Agarwal et al. (2009), Lusardi and Tufano
(2009), any investor lacking basic and advanced financial literacy is more likely to save
less and borrow more loans while Lusardi and Mitchell (2007) assert that the same
investor would fail to plan for retirement and participate less in investment activities like
the stock market.
Since financial literacy promotes better investment decision making and planning for the
future, then it is of no surprise that high financial literacy levels are key in stimulating
participation in the market. High financial literacy levels solves so many issues in the
financial markets; proper understanding of the products and services, allows controlled
risk taking and hedging, building of good investment strategies, portfolio formulation
and learning from one’s own mistakes (Christelis et al., 2010).
2.4.2 Relationship between Financial Literacy Levels and Types of Investments
made
In one of their studies, Kimball and Shumway (2010) found out that investors with lower
financial literacy levels like to assume and get emotionally involved in the choices they
make in the financial markets. Thus it’s not a surprise to learn that they apply strategies
25
based on their own emotions and perceptions which would eventually fail to perform.
Other researchers such as Guiso and Jappelli (2008) have concluded in one of their
researches that portfolio diversification is a sure sign of high financial literacy levels and
a lack of diversification in the investments made translates to financial illiteracy. The two
researchers argue that financially illiterate investors would choose bond investing over a
portfolio made of stock and bonds as they do not understand the relationship between
portfolio diversification and the returns made in the financial markets neither do they
understand the benefits vis-à-vis the risks involved in choosing different types of products
in the financial markets. To financially illiterate investors there is no correlation
whatsoever between diversification and the returns ripped at the end of the investment
period. Financially literate individuals hold portfolios with different types of products and
services.
Consequently, Grinblatt et al. (2010) argued that investors with high intelligent quotients
(IQ) coupled with high financial literacy levels and average cognitive abilities always use
portfolios to group their investments before investing. This practice protects them from
the risky nature of their investments. It is also important to note that portfolios with
mutual funds are the most preferred by these types of individuals. Goetzmann and Kumar
(2008) have supported the above finding and have added that, stock selection and
portfolio formations are all characteristics of financially literate individuals.
Grinblatt et al. (2010), explains that financially literate investors have a tendancy to mix
risky assets with less risky assets. They maintain that, financially literate investors would
invest in stocks(risky) and at the same time their portfolio would include mutual funds
and bonds (less risky investments). Meanwhile financially illiterate investors prefer
investing in bonds and mutual funds than investing in stocks because they relate stocks
with ambiguity. Therefore it’s only obvious that they usually shun away from investing in
stocks at all, a few of them would consider investing in bonds or mutual funds the rest
would just not participate in the financial markets. Note that, Grinblatt et al. (2010) also
found that financially illiterate investors are mostly momentum investors. This speaks
volumes on the strategies they normally use; strategies based on feelings and emotions.
Investing with emotions can only expose an investor towards risky investments.
26
2.5 Chapter Summary
This chapter provides a theoretical background on all the study’s objectives, thus under
the relationship between financial literacy and demographic factors such as age, income,
gender and occupation the chapter provides numerous researches to show that there is a
relationship between financial literacy and all the demographic factors mentioned above.
The chapter outlined the existing debate on the relationship between financial literacy and
financial education and also provided enough literature to suggest there exists a
relationship between financial literacy and investment decisions such as stock market
participation and choice of investment vehicle.
Chapter Three, will focus on the research design and methodology (how the data was
collected, analyzed and presented).
27
CHAPTER 3
3.0 RESEARCH METHODOLOGY
3.1 Introduction
The objective of the study was to investigate financial literacy levels of Kenyan investors
and how it affects their decisions in the Nairobi Securities Exchange (NSE). This chapter
will provide an in depth view of the research design and the population under study, later
it
will tackle the sampling frame, sampling techniques and sampling size of the
population under study which were used in the collection of the data. The data collection,
research procedures and analysis methods will also explained.
3.2 Research Design
A descriptive research design was employed in this study. A descriptive research design,
can be defined as a study that focuses on bringing out patterns and trends but does not
focus on showing causality among its different elements (Darren and Schultz, 2002).The
descriptive research design was used to investigate the extent to which financial literacy
is associated with other variables (demographic factors, financial education, investment
decisions) such that predictions can be made based on the level of association.
Demographic factors (income, age, occupation and gender) and financial education were
the independent variables while financial literacy was the dependent variable in specific
objectives 1 and 2. In the last specific objective, investment decisions (consultation,
preferred investment tool, use of portfolio and frequency of participation in the NSE)
were the dependent variables while financial literacy was the independent variable.
3.3 Population and Sampling Design
3.3.1 Population
The population in this research study was focused on all individual investors in Kenya
who invest in the NSE. According to the CDSC of Kenya, there were a total of 1.9
million individual investors in Kenya as at 31st July 2013.
28
3.3.2 Sampling Design
3.3.2.1 Sample Frame
The CDSC register was the sampling frame used; it contained all registered individualinvestors. All investors must have CDS accounts to invest in the NSE. The CDSC register
contained a list of one million and nine hundred thousand local investors in the Nairobi
Securities Exchange.
3.3.2.2 Sample Technique
The non-probability sampling method preferred in this study was the convenience
sampling technique. According to Cooper and Schindler (2001), Non-probability
sampling is sampling done without consideration of equity of selection among the
elements in the population. According to Welman and Kruger (2001), homogenous
subjects are best handled by using an effective sampling technique such as convenience
sampling. The technique allowed the researcher to get a higher response rate as the
respondents were easily available outside the brokerage firms and financial institution
(bank). Time was also saved and there was no need to travel long distances in search of
particular elements of the population. Moreover, the technique was inexpensive and met
the set budget for the research as there was no elaborate set up required.
3.3.2.3 Sample Size
A sample is a representative portion of the whole population (Brown, 2009).A sample
size of 400 was selected from a total population of 1,900,000 individual investors who
participated in the Nairobi Securities Exchange. This is because a confidence level of
95% while using a population of 1,900,000 must have a sample size of 400 subjects
picked from Nairobi only. The individual investors in Nairobi were chosen because they
had different demographic characteristic thus allowed for viable predictions to be made.
(Calder et al., 1981).
The following formula has been recommended by Yamane (1973):
Where:
𝒏=
𝑵
𝟏 + 𝑵𝒆 𝟐
n is the sample required
N is the total population
29
e2 is the probability error
3.4 Data Collection Methods
A structured questionnaire with three sections which had both open and closed ended
questions was used. In the case of closed ended questions, dichotomous and multiple
choice questions were used to collect data from the respondents. Section one of the
questionnaire gathered data on demographics of the subjects i.e. income, age, gender and
occupation (where income, age, gender and occupation were independent variables and
financial literacy is the dependent variable) while section two of the questionnaire
gathered information on financial education received by the subjects(financial education
acting as an independent variable and financial literacy is the dependent variable) and
finally the last section of the questionnaire gathered data on investment decisions made
by the investors in the NSE (investment decisions were the dependent variables and
financial literacy the independent variable). Sections one, two and three of the
questionnaire provided adequate data on objectives one, two and three respectively for
analysis.
3.5 Research Procedures
A pilot test was organized to measure the validity and reliability of the questionnaire and
the test model. Pre-testing was done by administering the questionnaire to 50 respondents
outside Dyer and Blair (brokerage firm) and Faida Investment bank (Bank) in Nairobi.
Efficiency and objectivity of the study was achieved by implementing the pilot study and
ironing out any ambiguities and irrelevancy. After assessing the performance of the pilot
study and the necessary changes effected, the questionnaires were distributed in the
targeted locations.
The researcher strategically positioned himself in areas where individual investors were
likely to visit including the stock brokerage firms, banks etc.
and handed the
questionnaires to the respondents. The stock brokerage firms visited include Dyer and
Blair, Apex Africa Capital Limited and Drummond and Company limited while the banks
visited included Faida investment bank limited and CFC Stanbic Financial Services
Limited.
30
To improve the response rate of the respondents, the questionnaire made use of closed
ended questions (such as dichotomous and multiple choice questions) so that the
questionnaire took less time to fill and saved the respondents from lengthy
explanations(open ended questions).The respondents were promised their own copy of
the research after successful completion of the research. Research assistants helped the
respondents to answer the questionnaires. Recruited research assistants remained with the
respondents as they continued answering the questionnaire (to offer any assistance if
necessary) and they also helped in swift collection of the data for the study. These
research assistants were familiarized with the study and commitment to the study was a
factor in their recruitment.
The researcher allowed the respondents 10-15 minutes to answer the questionnaires after
which he collected the questionnaires. Answered questionnaires were checked, to find out
if all the questions had been answered.
3.6 Data Analysis Methods
The two methods used to analyze data are descriptive and associative.
Descriptive
statistics used include frequencies and measures of central tendencies (i.e. mean) while
the only measure of association used was chi-square test in all the three objectives; the
chi-square test would highlight relationships and differences between or among the
variables. The Statistical Package for Social Sciences (SPSS) was used to analyze the
data, later the data was presented in form of tables and figures. A model to test the levels
of financial literacy of the investors was also used, the results of which would aid in
answering all the three objectives.
3.7 Chapter Summary
The chapter covered the research methodology of the study; descriptive research design
has been used with a sample size of 400 individual investors drawn from 1,900,000
individual investors (population) in Kenya. The sampling technique used to select a
sample from the population is convenience sampling. A structured questionnaire would
be used to collect data, with the help of model to test the financial literacy level of the
respondents. Data analysis was done using spreadsheets and SPSS, information was later
presented in pie charts and bar graphs.
31
The findings were presented in chapter 4, in form of tables and figures after the data was
analysed using SPSS.
32
CHAPTER 4
4.0 RESULTS AND FINDINGS
4.1 Introduction
In this chapter, the data collected during research has been analyzed and reported. The
data collected was in line with the specific objectives the study sought to achieve. A total
of 400 questionnaires were given to individual stock investors in Nairobi . Three hundred
sixty respondents gave back there questionnaire which indicate a 90% response rate.
Collected data was cleaned, coded and analysed using various tools. The findings are
presented below using charts, tables and graphs.
Table 4.1: Analysis of Response
Male
Population
Completed questionnaires
Population Response rate
Female
216
216
Total
184
144
400
360
90.00%
4.2. Demographic Analysis
4.2.1. Age of Respondent
Out of the 360 respondents, 10% were 51-60years old, 20% were 41-50years old, 31.94%
were aged between 31-40 years, 26.11% were 21-30years old and 11.94% of the
respondents were below 20 years. Figure 4.1 shows the age distribution across the 360
respondents.
33
100%
90%
80%
70%
60%
50%
31.94%
40%
30%
20%
20.00%
26.11%
11.94%
10.00%
10%
0%
51-60 Years
41-50 Years
31-40 Years
21-30 Years
Below 20 Years
Figure 4.1: Age Distribution of Respondents
4.2.2. Occupation
Students comprised of 18.06% of the respondents, 10% were lawyers, 16.39% were
computer technicians, 8.61% were doctors, 34.17% of them were accountants and the rest
were retired persons. This is shown in Figure 4.2.
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
34.17%
18.06%
10.00%
16.39%
8.61%
Figure 4.2: Occupation of the Respondents
34
12.78%
4.2.3 Level of Income of the Respondents
On income distribution, 6.11% of the respondents were earning Ksh.201,000 and above,
15% between Ksh.151,000 to Ksh.200,000, and 25% earning below Ksh.50,000. This is
shown in Figure 4.3.
100%
90%
80%
70%
60%
50%
36.94%
40%
25.00%
30%
20%
10%
15.00%
16.94%
6.11%
0%
Figure 4.3: Income Distribution of Respondents
4.2.4. Level of Education of the Respondents
The highest level of education attained by 25% of the respondents was primary school
level, 35% had secondary level education while the rest had university education as
shown in Figure 4.4 below.
35
15%
5%
25%
Primary level
20%
Secondary level
Undergraduates
35%
Graduates
Post graduates
Figure 4.4: Level of Education of the Respondents
4.2.5. Field of Study
Those without university education made up 40% of the respondents. Those currently in
university or have graduated made up 60% and are /were trained in various professions:
9.72% in medicine, 6.94% in law, 59.03% in finance among others as shown in Figure
4.5 below.
13.89%
9.72%
10.42%
Medicine
Finance
6.94%
Law
59.03%
Education
IT
Figure 4.5: Field of Study of the Respondents
36
4.2.6. Sources of Financial Education
Those with university education used various sources of financial education: 34.72%
gained their financial education from friends/relatives, 32.41%
sourced financial
education from investment groups while 2.31% of the remaining respondents gained their
financial knowledge from other sources. This is shown in Figure 4.6.
2.31%
7.41%
23.15%
Workplace
32.41%
Friends
Investment groups
34.72%
Other
Media
Figure 4.6: Sources of Financial Education
4.3. Relationship between Financial literacy and Demographic Factors
4.3.1. Financial Literacy Analysis
The respondents were first asked to provide answers to a financial literacy quiz, the quiz
contained basic numerical and advanced literacy questions. It was apparent from the
analysis that most of the respondents performed well in part one of the quiz than in part
two.The table below analyses the performance per question answered by the respondents,
it shows the type of question asked and the percentage of respondents who answered the
questions correctly or otherwise.
37
Table 4.2:Performance of the Respondents on the Financial Literacy Quiz
QUESTION
TOPIC
RESPONDENTS WHO RESPONDENTS WHO
ANSWERED
ANSWERED
CORRECTLY(%)
INCORRECTLY(%)
100%
0%
100%
0%
100%
0%
90%
10%
100%
0%
100%
0%
PART I: NUMERACY QUESTIONS
1
BASIC
ARITHMETICS
2
BASIC
ARITHMETICS
3
BASIC
PROBABILITY
4
BASIC
ARITHMETICS
5
BASIC
ARITHMETICS
6
SIMPLE INTEREST
PART II: ADVANCED FINANCIAL LITERACY QUESTIONS
7
TIME VALUE OF 70%
30%
MONEY
8
INVESTMENTS
(PORTFOLIO
60%
40%
50%
50%
40%
60%
95%
5%
80%
20%
IN
STOCKS)
9
INVESTMENT
(BONDS)
10
INVESTMENTS
(STOCKS
AND
BONDS)
11
INVESTMENTS
(STOCKS
AND
BONDS)
12
RISK/RETURN
In the numeracy section, respondents answered all the questions correctly except for
question 4 where 10% failed. In the advanced literacy section; question 10 recorded the
38
worst performance with only 40% getting it correct, while the best performed question
was 11 with 95% correct responses.
4.3.1.1. General Information on the Financial Literacy Test
When graded on overall performance, 27.8% respondents scored between 75%-100%,
16.67% scored between 50-75%, 55.6% managed to score between 25%-50% while none
of the respondents scored below 25%. The pass mark for the financial literacy test was
75% which was attained by 27.8% of the respondents.
100%
90%
80%
70%
60%
50%
40%
55.56%
30%
20%
10%
0%
27.78%
16.67%
0.00%
0-24%
25%-49%
50%-74%
75-100%
Figure 4.7: General Performance on the Financial Literacy Test
4.3.2. Relationship between Financial Literacy and Gender
On the relationship between gender and financial literacy,
25.46% of the male
respondents were financially literate while 31.25% of the female respondents were
literate, as shown in Figure 4.8.
39
120%
100%
80%
68.75%
74.54%
Financially illeterate
60%
Financially Literate
40%
20%
31.25%
25.46%
0%
Male
Female
Figure 4.8: Relationship between Financial Literacy and Gender
4.3.2.1 .Chi-Square Test on the Relationship between Financial Literacy and Gender
The Chi-Square test of significance between financial literacy and gender revealed the
following results. The computed X2 statistic was 1.422. The critical X2 value at 95%
confidence level and 3 degrees of freedom was 12.838.Since the computed chi-square
value is less than critical value the conclusion is, there is no significant relation between
the financial literacy and gender as shown in the table below:-
Table 4.3:Chi-square Test between Financial Literacy and Gender Categories.
Expected
counts
Actual counts
Male and Literate
Male and Illiterate
Female and Literate
Female and Illiterate
55
161
45
99
Chi square value
Chi Square
Values
60
156
40
104
Critical value
No significant relationship between financial literacy and gender.
40
0.416
0.160
0.625
0.240
1.442
12.838
4.3.3. Relationship between Financial Literacy and Age of Respondents
The analysis depicted that the financial literacy level of the respondents aged between
21-30 years was 53.19% while 31.3% aged between 31-40 years were also literate and
only 5.56% of the remaining respondents aged between 51-60 were literate.
120%
100%
80%
46.81%
68.70%
60%
94.44%
86.11%
Financially illeterate
95.35%
Financially literate
40%
53.19%
20%
0%
31.30%
5.56%
13.89%
4.65%
51-60 Years 41-50 Years 31-40 Years 21-30 Years
Below 20
Years
Figure 4.9: Relationship between Financial literacy and Age
4.3.3.1. Chi-Square Test on the Relationship between Financial literacy and Age
The Chi-Square test of significance between financial literacy and age revealed the
following results. The computed X2 statistic was 11.421. The critical X2 value at 95%
confidence level and 3 degrees of freedom was 12.838.Since the computed chi-square
value is less than critical value the conclusion is, there is no significant relation between
the
financial
literacy
and
age
as
shown
in
the
table
Table 4.4:Chi-square Test between Financial Literacy and Age Categories
Actual
counts
Expected
Chi-Square
counts
values
31-60 Years Literate
48
61.944
3.139
31-60 Years Illiterate
175
161.056
1.207
Below 30 Years Literate
52
38.056
5.110
Below 30 years Illiterate
85
98.944
1.965
Chi- square
value
11.421
Critical value
12.838
No significant relationship between financial literacy and age.
41
below:-
4.3.4. Relationship between Financial Literacy and Occupation
The analysis depicted that 52.85% of the accountants were financially literate, 25.81% of
the doctors and only 8.47% of computer repair technicians were literate.
120%
100%
80%
60%
47.15%
81.54%
83.33%
91.53%
74.19%
91.30%
Financially illeterate
40%
Financially literate
52.85%
20%
0%
18.46%
16.67%
8.47%
25.81%
8.70%
Figure 4.10: Relationship between Financial literacy and Occupation
4.3.4.1. Chi-Square Test on the Relationship between Financial Literacy and
Occupation
The Chi-Square test of significance between financial literacy and occupation revealed
the following results. The computed X2 statistic was 37.167. The critical X2 value at 95%
confidence level and 5 degrees of freedom was 16.75.Since the computed chi-square
value is greater than critical value the conclusion is, there is a significant relation between
the financial literacy and occupation as shown in the table below:-
42
Table 4.5:Chi-square Test between Financial Literacy and Occupation Categories.
Students & Accountants Literate
Students & Accountants Illiterate
Lawyers & Doctors Literate
Lawyers & Doctors Illiterate
Computer Technicians & Retired
Literate
Computer Technicians & Retired
Literate
Actual
Expected
Chi-Square
counts
counts
values
77
52.222
11.756
111
135.778
4.522
14
18.611
1.142
53
48.389
0.439
9
29.167
13.944
96
75.833
Chi square
value
5.363
37.167
Critical value
16.75
There is a significant relationship between financial literacy and occupation.
4.3.5. Relationship between Financial literacy and Levels of Income
The levels of income were put into orders/classes to solve for the randomness of the data
which would make the analysis and presentation of the data easier. 68.18% of the
respondents earning above Ksh.201,000 were literate while 40.98% earning Ksh.101,000Ksh.150,000 and 18.52% of those earning Ksh.151,000-Ksh.200,000 were financially
literate.
120%
100%
80%
31.82%
59.02%
81.48%
60%
40%
20%
77.44%
77.78%
Financially illeterate
68.18%
40.98%
18.52%
Financially literate
22.56%
22.22%
0%
Figure 4.11:Relationship between Financial literacy and Income
43
4.3.5.1. Chi-Square Test on the Relationship between Financial literacy and Income
The Chi-Square test of significance between financial literacy and income revealed the
following results. The computed X2 statistic was 28.704. The critical X2 value at 95%
confidence level and 9 degrees of freedom was 23.589.Since the computed chi-square
value is greater than critical value the conclusion is, there is a significant relation between
the financial literacy and income as shown in the table below:-
Table 4.6:Chi-square Test between Financial Literacy and Income Categories
Actual
counts
Expected
Chi-Square
counts
values
201,000 and above Literate
15
6.111
12.929
201,000 and above Illiterate
7
15.889
4.973
151,000-200,000 Literate
10
15.000
1.667
151,000-200,000 Illiterate
44
39.000
0.641
101,000-150,000 Literate
25
16.944
3.830
101,000-150,000 Illiterate
36
44.056
1.473
50,000-100,000 Literate
30
36.944
1.305
50,000-100,000 Illiterate
103
96.056
0.502
below 50,000 Literate
20
25.000
1.000
below 50,000 Illiterate
70
65.000
0.385
chi square
28.704
Critical value
23.589
There is a significant relationship between financial literacy and income.
4.4. Relationship between Financial Literacy and Financial Education
It was found that 50% of the graduates were financially literate, 36% of the postgraduates and only 16.67% of those with primary level education were literate.
44
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
83.33%
77.97%
66.10%
50.00%
64.00%
Illiterate
16.67%
22.03%
33.90%
50.00%
36.00%
Literate
Figure 4.12:Relationship between Financial literacy and Financial Education
4.4.1. Chi-Square Test on the Relationship between Financial Literacy and Financial
Education
The Chi-Square test of significance between financial literacy and financial education
revealed the following results. The computed X2 statistic was 25.456. The critical X2
value at 95% confidence level and 9 degrees of freedom was 23.589.Since the computed
chi-square value is greater than critical value the conclusion is, there is a significant
relation between the financial literacy and financial education as shown in the table
below:Table 4.7:Chi-square Test between Financial Literacy and Financial Education
Actual
counts
Chi-Square
Expected counts
values
Primary Level Literate
15
25.000
4.000
Primary Level Illiterate
75
65.000
1.538
Secondary Level Literate
26
35.000
2.314
Secondary Level Illiterate
100
91.000
0.890
Undergraduates literate
20
16.389
0.796
Undergraduates Illiterate
39
42.611
0.306
Graduates literate
30
16.667
10.667
Graduates Illiterate
30
43.333
4.103
Post Graduates literate
9
6.944
0.608
Post Graduates Illiterate
16
18.056
0.234
chi square
25.456
Critical value
23.589
There is a significant relationship between financial literacy and financial education.
45
4.5. The Relationship between Levels of Financial Literacy and Investment Decisions
in the NSE
4.5.1. Relationship between Financial literacy and Consultation
Out of the respondents who consulted a financial analyst, 76.85% were literate while
15.87% who did not consult a financial analyst were literate.
100%
23.15%
90%
80%
70%
84.13%
60%
Financially Illiterate
50%
Financially Literate
76.85%
40%
30%
20%
15.87%
10%
0%
Consult a financial
analyst
Do not consult a
financial analyst
Figure 4.13:Relationship between Financial literacy and Consultation
4.5.1.1. Chi-Square Test on the Relationship between Financial Literacy and
Consultation
The Chi-Square test of significance between financial literacy and consultation revealed
the following results. The computed X2 statistic was 124.977. The critical X2 value at
95% confidence level and 3 degrees of freedom was 12.838.Since the computed chisquare value is greater than critical value the conclusion is, there is a significant relation
between the financial literacy and consultation as shown in the table below:-
46
Table 4.8:Chi-square Test between Financial Literacy and Consultation
Actual
counts
Chi-square
Expected counts
values
Consult Literate
83
36.90
57.594
Consult Illiterate
25
71.10
29.890
Do not consult Literate
40
86.10
24.683
Do not consult Illiterate
212
165.90
12.810
chi square value
124.977
Critical value
12.838
There is a significant relationship between financial literacy and consultation.
4.5.2. Relationship between Financial Literacy and Portfolio Usage
When investing, 77.61% of the respondents who used portfolios were literate while only
13.65% of the respondents who did not use a portfolio were literate.
100%
90%
80%
70%
Financialy Illeterate
60%
50%
40%
Financially Literate
77.61%
30%
20%
13.65%
10%
0%
Use of Portfolios
Don't use portfolio's
Figure 4.14. Relationship between Financial Literacy and Portfolio Usage
4.5.2.1. Chi-Square Test on the Relationship between Financial Literacy and Use of
Portfolios
The Chi-Square test of significance between financial literacy and use of portfolios
revealed the following results. The computed X2 statistic was 112.082. The critical X2
value at 95% confidence level and 3 degrees of freedom was 12.838.Since the computed
47
chi-square value is greater than critical value the conclusion is, there is a significant
relation between the financial literacy and use of portfolios as shown in the table below:Table 4.9:Chi-square Test between Financial Literacy and Portfolio Usage
Expected
Chi-square
counts
values
Use of portfolio Literate
52
18.61
59.901
Use of portfolio Illiterate
15
48.39
23.039
Don't use portfolio's Literate
40
81.39
21.048
Don't use portfolio's Illiterate
253
211.61
8.095
chi square
value
112.082
Critical value
12.838
There is a significant relationship between financial literacy and portfolio usage.
Actual counts
4.5.3. Relationship between Financial Literacy and Frequency of Participation in the
Nairobi Securities Exchange
Out of the respondents who have participated in the Nairobi Securities Exchange for a
period of less than 1 year none of them was found to be financially literate. From the
respondents who have participated in the Nairobi Securities Exchange for 1-2 years only
33.33% were literate. While, those who participated in the Nairobi Securities Exchange
for 2-3 years were all found to be literate.
120%
100%
22.22%
80%
60%
66.67%
100.00%
Financially Illiterate
100.00%
77.78%
40%
33.33%
20%
0%
0-1 year
1-2 years
2-3 years
More than 3
years
Figure 4.15: Relationship between Financial Literacy and Frequency of
Participation in the Nairobi Securities Exchange
48
Financially Literate
4.5.3.1. Chi-Square Test on the Relationship between Financial Literacy and
Frequency of Participation in the NSE
The Chi-Square test of significance between financial literacy and frequency of
participation in the NSE revealed the following results. The computed X2 statistic was
230.581. The critical X2 value at 95% confidence level and 3 degrees of freedom was
12.838.Since the computed chi-square value is greater than critical value the conclusion
is, there is a significant relation between the financial literacy and frequency of
participation in the NSE as shown in the table below:-
Table 5.0:Chi-square Test between Financial Literacy and Frequency of
Participation in the NSE
Expected
Chi-square
Actual counts counts
values
0-2 years Literate
10
69.44
50.88
0-2 years illiterate
240
180.56
19.57
3 years and above Literate
90
30.56
115.65
3 years and above Illiterate
20
79.44
44.48
chi square
value
230.581
Critical value
12.838
There is a significant relationship between financial literacy and frequency of
participation in the NSE.
4.5.4. Relationship between Financial literacy and Respondents’ Preferred
Investment Tool in the NSE
Out of the respondents, who chose bonds as their preferred investment vehicle, only
6.10% of them were financially literate while those investing in stocks, 70.21% of them
were financially literate.
49
100%
90%
22.39%
29.79%
80%
70%
60%
93.90%
Financially Illeterate
50%
40%
77.61%
70.21%
Financially literate
30%
20%
10%
6.10%
0%
Stocks
Bonds
Both Stocks and
Bonds
Figure 4.16:Respondents Preferred Investment Tool
4.5.4.1. Chi-Square Test on the Relationship between Financial Literacy and
Preferred Investment Tool in the NSE
The Chi-Square test of significance between financial literacy and preferred investment
tool in the NSE revealed the following results. The computed X2 statistic was 182.762.
The critical X2 value at 95% confidence level and 5 degrees of freedom was 16.75.Since
the computed chi-square value is greater than critical value the conclusion is, there is a
significant relation between the financial literacy and preferred investment tool in the
NSE as shown in the table below:-
50
Table 5.1:Chi-square Test between Financial Literacy and Preferred Investment
Tool in the NSE
Actual
counts
Both stocks and bonds
Literate
Both stocks and bonds
Illiterate
Stocks literate
Stocks Illiterate
Bonds Literate
Bonds Illiterate
Expected counts
52
18.611
15
33
14
15
231
48.389
13.06
33.94
68.33
177.67
chi square value
Chi-Square
values
59.901
23.039
30.468
11.719
41.626
16.010
182.762
Critical value
16.75
There is a significant relationship between financial literacy and preferred investment
vehicle.
4.6. Chapter Summary
The data analyzed revealed significant relationship between financial literacy and both
occupation and income of the respondents(demographic factors), financial education and
all investment decisions (use of portfolios, investment tool used, frequency of
participation and consultations). Chapter five will discuss the findings, provide conclusive
remarks and recommendations.
51
CHAPTER 5
5.0 DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
This chapter will cover the summary of the study, discuss and make recommendations on
each objective and later suggest ideas for further research.
5.2 Summary
The purpose of the study was to investigate financial literacy levels of Kenyan individual
investors and how financial literacy affects their investment decisions. The specific
objectives of the study were: to investigate the relationship between financial literacy and
key demographic factors such as age, income, occupation and gender, to investigate the
relationship between financial literacy and financial education, and to investigate the
relationship between levels of financial literacy and investment decisions in the NSE
(Nairobi Securities Exchange).
To achieve the purpose of the study, the researcher used a descriptive study approach
which focused on a population of 1.9 million individual investors in Kenya; the sampling
frame used was the CDSC register of all individual investors in the NSE. The
convenience sampling technique was used to draw a sample size of 400 respondents i.e.
individual investors from the total population, primary data from the respondents was
collected using structured questionnaires. Once the data was collected, the researcher
carried out analysis using descriptive and inferential statistics; percentages, frequencies,
means and chi-square tests and also made use of a financial literacy model which helped
in answering all three objectives. The findings were then presented in tables, pie charts
and graphs.
The major finding of this study in regards to the financial literacy levels of Kenyan
investors is that, a majority of the respondents have very low financial literacy levels
which has affected their investment decisions in the NSE .Only one hundred of the
respondents from the total three hundred and sixty had registered high literacy levels in
the NSE.
52
The relationship between financial literacy and demographic factors such as gender,
income, occupation and age was investigated. The findings showed that financial literacy
was significantly related with all the demographic factors except gender and age.
The findings further established that financial education directly affects the financial
literacy levels, with individual investors with formal or informal schooling in finance
registering higher passes in the financial literacy test.
Moreover, the chi-square tests conducted to test relationship between levels of financial
literacy and investment decisions in the NSE i.e. portfolio investing, frequency of
participation, type of investment vehicles and professional consultations, also revealed
that there was a significant relationship between investment decisions and financial
literacy. Financial literacy affected the decision making of the individual investors in the
NSE.
5.3 Discussion
5.3.1 Relationship between Financial Literacy and Key Demographic Factors such
as Age, Income, Occupation and Gender
From the findings of the study, only twenty eight percent (one hundred ) of the three
hundred and sixty respondents passed the financial literacy quiz. The chi-square test did
not show a relationship between financial literacy and gender. Although out of the one
hundred respondents who passed the literacy test, fifty five percent of them were male
while forty five percent were female. Thus, there was a small difference between number
of male and female respondents who passed the literacy test. The results obtained from
the study, differed with some of the previous researches done on the link between gender
and financial literacy; Goldsmith and Goldsmith (1997) argued that as a result of their
lack of disinterest and ignorance in personal finance and investments , women scored
worse than men in financial literacy tests .On another hand the results obtained from the
study related with what other researchers observed in their studies; Koshal et al. (2008)
concluded that gender cannot determine financial literacy when they carried out their
research in India on 494 MBA(Masters in Business Administration) students.
From the one hundred respondents who had passed the test, fifty percent of them
(majority) were between ages 21-30, fifty percent of the remainder constituted the
53
remaining age groups .This means that young adults (aged 21-30 years) had higher
literacy levels than any other age group. Thus financial literacy levels diminished with
increase in age. This finding, does not
relate with a research done in Sweden by
Almenberg and Säve-Söderbergh (2011) where the middle age group (35-50 years) old
appeared to be highly financially literate compared to old age groups (51-60 years old)
and young people aged between 16-25 years old. A chi-square test of significance
between financial literacy revealed that there is no relationship between financial literacy
and age. Thus, financial literacy was not dominant with any age group and is independent
of age.
Regarding the relationship between financial literacy and occupation of the respondents,
sixty five percent of the financially literate respondents were accountants. The category
with the least number of people who passed was the retirees’ category. This supports the
arguments of Worthington (2004) who discovered that entrepreneurs, white collar job
employees working as accountants, business executives etc displayed the highest level of
financial literacy than the unemployed and blue collar job employees , which is in line
with findings of Almenberg and Säve-Söderbergh (2011) for Sweden.Moreover, further
analysis showed that the type of occupation also mattered hence the large proportion of
accountants were found to possess high financial literacy levels (instead of doctors,
computer repair technicians etc). This is so, because accountants have vast experience and
knowledge regarding financial aspects due to the nature of their occupation hence they
were the majority who passed the literacy test. The chi-square test of significance
between financial literacy and occupation revealed that there is a significant relationship
between the two, thus financial literacy is dependent on the occupation of the individual.
With regard to the relationship between financial literacy and Income, majority of the
financially literate respondents; thirty percent belonged to the category that earned
between Ksh. 50,000-Ksh.100,000. The category that had the least number of financially
literate respondents was the Ksh.151,000-Ksh.200,000 category with only ten. The
findings of the study reveal that the middle income earners (according to the study’s
categories)
i.e,
the
(Ksh.50,000-Ksh.100,000)
and
(Kshs101,000-Kshs150,000)
categories, had the highest number of financially literate respondents. This study suggests
that at low income levels the financial literacy levels are lower, while the financial
54
literacy levels continue to rise with increase in income. Delavande et al. (2008) assert
that, numerous studies have suggested that individuals are driven to gain financial literacy
so that they can easily manage their rising income. The chi-square test of significance
between financial literacy and income revealed that there is a significant relationship
between the two, thus financial literacy is dependent on the income of the individual.
5.3.2 Relationship between Financial literacy and Financial Education
From the findings of this research most of the educated respondents, especially those with
a financial education background, constituted the majority of the respondents who were
financially literate.
Fifty nine percent of the financially literate respondents were from undergraduate,
graduates and post-graduates levels. These fifty nine percent, had majored in finance in
their respective schools of higher learning. Thirty three percent of the undergraduates,
graduates and post-graduates were financially illiterate; these included doctors, lawyers
among others. This proves the crucial role played by financial education on financial
literacy levels. The remaining forty one percent had only pursued education up to the
secondary level and primary level. This can simply be explained by putting into
consideration the fact that financial education can be learned anywhere even after school.
The chi-square test of significance between financial literacy and financial education
revealed that there is a significant relationship between the two, thus financial literacy is
dependent on the financial education. Further, the study found sixty six percent of those
financially illiterate had only pursued education up to primary and secondary levels and
only a small portion of the respondents; fifteen percent (15%) managed to pass the
financial literacy test because of further financial education. This simply shows that,
financial education plays an important role in improving financial literacy levels, as
depicted by a financially literate majority who pursued financial education to schools of
higher learning.
The results of these findings can be further illustrated and compared by Abreu and
Mendes (2010), who surveyed local Portuguese investors and concluded that portfolio
diversification practiced by Portuguese investors was aided by high levels of education
that promoted high financial literacy levels. This shows the important role played by
55
financial education in attaining higher literacy levels. Also, Guiso and Jappelli (2009)
managed to gather similar results from Italian investors. On the same note, Volpe et al.
(2002) investigated a group of online investors’ financial literacy and concluded that high
financially literate investors had graduate degrees while the investors with low financial
literacy did not possess graduate degrees.
5.3.3Relationship between Levels of Financial Literacy and Investment Decisions in
the NSE
Regarding investment procedures such as the use of portfolios while investing, about
eighty one percent of the total number of respondents that did not make use of portfolios.
It is important to note that, out of the a hundred financially literate respondents, fifty two
percent made use of portfolios while investing in the NSE. This shows, high financial
literacy levels go hand in hand with sound investment decisions, in this case they made
use of portfolios as a hedging technique to protect their investments. The chi-square test
of significance between financial literacy and use of a portfolio revealed that there is a
significant relationship between the two.
The study revealed that, thirty percent of the total number of respondents, confirmed that
they made use of a financial analyst before undertaking an investment decision while
seventy percent of the respondents, did not make use of a financial analyst. It was not
surprising therefore, to find that seventy seven percent of the respondents who made use
of a consultant were financially literate while eighty four percent of the respondents who
did not consult, were financially illiterate.The chi-square test of significance between
financial literacy and consultation revealed that there is a significant relationship between
the two.
Data analyzed revealed that ninety percent of the respondents who were financially
literate have participated in the NSE for more than three years. This result can be
interpreted by understanding that; high financial literacy levels give the investors enough
confidence to participate frequently and for longer periods in the NSE. This finding
coincides with what Lusardi et. al,(2007) found out in their study; lack of financial
market participation and stock ownership comes about from the misconceptions and
misunderstandings of the financial markets products especially stocks. Lusardi and his
56
colleagues concluded that financial literacy levels motivated investors to hold more
stocks for longer and consequently leads to frequent participation in the financial markets.
Furthermore, they found that those who score high on basic literacy are
disproportionately more likely to participate in the stock market frequently. The chisquare test of significance between financial literacy and frequency of participation
revealed that there is a significant relationship between the two.
Finally, the study revealed that out of the three hundred and sixty respondents, sixty eight
percent of them preferred bonds as their investment vehicle, thirty three percent preferred
investing in stocks and fifteen percent preferred investing in both. Not surprisingly
though, fifty two percent of the financially literate respondents were investing in both
stocks and bonds followed by thirty three percent who invested in stocks and the
remainder were investing in bonds. This finding can easily be explained by considering
that, different levels of financial literacy play a crucial role in determining the investment
vehicle used. The financially literate group investing in both stocks and bonds, find it
easy and cost effective to cope with two different types of securities in the market as they
have the knowhow to manage both effectively. Meanwhile the fifteen percent (investing
in bonds) find it difficult to understand how it can be rewarding to invest in stocks and
opt to use a much safer route (bonds) without being affected by the volatility of the
financial market (stocks). Grinblatt et al. (2010), argues that financially literate
individuals are not afraid to invest in stocks and hedge their investments with less risky
securities such as bonds and mutual funds. The reverse is true for the investors with low
financial literacy levels; they fear the investments in stocks and shun away from anything
to do with stocks because they think it is a loose-loose situation as the stock market is
rarely predictable.The chi-square test of significance between financial literacy and
preferred investment vehicle revealed that there is a significant relationship between the
two.
5.4 Conclusion
5.4.1 Relationship between Financial Literacy and Key Demographic Factors such
as Age, Income, Occupation and Gender
The research concluded that financial literacy has a significant relationship with income
and occupation of the investor, but has no relationship with gender and age. This implies
57
that whether male or female, young or old, all have an equal footing in possessing high
financial literacy levels.
5.4.2 Relationship between Financial Literacy and Financial Education
It was also concluded from the research that, financial education played a major role in
improving financial literacy levels among the investors. The significant relationship was
evident between the two as was shown by the chi-square test. Financial education
guarantees high financial literacy levels, thus investors can make wise investing decisions
in the financial markets. Financial education can be taught formally in schools or
informally in finance clubs, work group, seminars etc.
5.4.3 Relationship between Levels of Financial Literacy and Investment Decisions in
the NSE
The research found that financial literacy affects the type of investment decisions made
by the investors. The chi-square test revealed a significant relationship existed between
financial literacy and investment practices such as portfolio investing, financial analysts
consultations, frequency of participation by the investors and the type of investment
vehicle used. Some of the ways financial literacy impacts investment decisions include:
high financial literacy levels lead to frequent participation in the NSE, financially literate
investors opt to invest in both stocks and bonds as their preferred investment vehicle and
also seek financial advice, use portfolios and invest in mutual funds.
5.5 Recommendation
5.5.1 Recommendations for Improvements
5.5.1.1 Relationship between Financial Literacy and Key Demographic Factors such
as Age, Income, Occupation and Gender
The study recommends that the government mandate both white and blue collar job
employers whose jobs have no bearing in finance to conduct seminars on financial
aspects to create awareness and improve literacy to their employees. This will
compensate for the lack of financial aspects in their occupation.
58
5.5.1.2 Relationship between Financial Literacy and Financial Education
The study recommends that Kenya addresses the issue of financial education in schools as
early as possible, primary and secondary schools should have finance subjects in their
curriculum to instill behaviors of saving and investing at younger ages, this will not only
boost literacy levels in investing but would help in the long run to grow the economy.
5.5.1.3 Relationship between Levels of Financial Literacy and Investment Decisions
in the NSE
The study recommends that before individual investors are allowed to participate in the
NSE, they should be instructed to take part in a short financial literacy course on
securities and hedging techniques. This would raise literacy levels in the investors, and
they would make better decisions in investing such as consulting, using portfolios etc.
5.5.2 Recommendations for Further Studies
The study was limited by financial aspects.Further studies into financial literacy and its
impact in investing can be done to cover a greater scope and help identify even more
intriguing facts about why financial literacy is a necessity to any investor and country.
How financial literacy affects investment decisions was the focus of this study. Similar
studies should be conducted on other effects of financial literacy to enable us obtain a
clear picture of the critical role financial literacy plays in improving investment decisions
and the economy of a country as a whole.
59
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APPENDICS
APPENDIX 1- INTRODUCTION LETTER
Mohamed Mahfudh,
United States International University,
P. O. Box 14634-00800,
Nairobi, Kenya.
Dear Respondent,
RE: REQUEST TO TAKE PART IN A RESEARCH STUDY
I am a graduate student at United States International University in Nairobi carrying out a
research study for the completion of my Masters degree in Business Administration. My
research topic is ‘Financial literacy and investment decisions; the case of individual
investors in the Nairobi Securities Exchange’.
Attached with this letter is a financial literacy quiz and a questionnaire to help collect
data for the research. I would humbly request you to aid my research by attempting the
financial literacy quiz and later filling out the questionnaire. Please make sure you
answer all the questions.
Your participation will be critical for the study and I assure you not to worry about
confidentiality of the information you give out, as your information would only be used
for academic purposes only and not for other means.
I will make a point of sending you the whole research when it’s done, thus you would
witness firsthand how your contribution has aided my findings and conclusions. Feel free
to input your address at the back of the questionnaire if you would like a copy of the
research when it’s done. Thank you for your time and cooperation.
Sincerely,
Mohamed Mahfudh.
69
APPENDIX 2- QUIZ
How to fill the financial literacy quiz
The quiz has 1 section with 2 parts, namely Part 1 and Part 2 .
Part 1 – This section will contain a total of six questions. The questions will test your
ability to deal with numerical problems. Kindly fill all the questions by filling the spaces
provided.
Part 2 – In this section, there will also be a total of six questions, here your basic
understanding of tools of investments will be tested and you will be required to fill your
answers in the spaces provided.
Please answer all questions.
70
Section A.
Part 1: Numeracy questions.
Q1 You buy a book for KSH 85 and pay with KSH 100. How much change should you
get?
Q2 A shop has a sale and offers all items at half price. A chair costs KSH 3,000 before
the sale. How much does it cost in the sale?/ In a sale, a shop is selling all items at half
price. Before the sale, a sofa costs KSH300. How much will it cost in the sale?
Q3 If the probability of getting a disease is 10 per cent, how many people out of 1,000
would be expected to get the disease?/ If the chance of getting the disease is 10 per cent,
how many people out of 1,000 would be expected to get the disease?
Q4 .A car dealer offers a second hand car for KSH 60,000. This is two-thirds of what it
cost new. How much did the car cost new?/ A second hand car dealer is selling a car for
KSH6,000. This is two-thirds of what it cost new. How much did the car cost new?
Q5. Five people win a lottery and share the prize. If the prize they are sharing is 2 million,
how much does each of them get?/ If 5 people all have the winning numbers in the lottery
and the prize is KSH2 million, how much will each of them get?
Q6 Your savings account has KSH 200 . The interest is 10 per cent per annum in the
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Q6.Let’s say you have KSH200 in a savings account. Interest rate per annum is 10 per
cent. How much will you have in the account at the end of two years?
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Part II: Advanced financial literacy questions
Q7. Suppose the interest on your bank account is 1 per cent and inflation is 2 per cent.If
you keep your money in the account for a year, will you be able to buy more, as much, or
less at the end of the year?/ Imagine that the interest rate on your savings account was 1
per cent per year and inflation 2 per cent per year. After 1 year, the money in the account
would be able to purchase more things, purchase the same things or purchase less of the
normal household things?
Q8 .Purchase of mutual fund shares is much safer than stock purchase in one company.
True or false?
Q9 Bonds are securities that pay a fixed interest during a specified time period. If interest
rates go down, what happens to bond prices?/ If the interest rate falls, what should happen
to bond prices?
Q10 Which has had the higher historical long-run return, stocks or bonds?/ Considering a
long time period (for example 10 or 20 years), which asset normally gives the highest
return?[savings accounts/ bonds/stocks]
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Q11 Stocks tend to fluctuate more in value than bonds. True or false?/ Normally, which
asset displays the highest fluctuations over time: savings accounts, bonds or stocks?
Q12. An investment that pays an above average return is likely to have above average
risk. True or false
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APPENDIX 3- QUESTIONNAIRE
How to fill the questionnaire
The questionnaire has 1 section , with three parts namely parts 1, 2 and 3.
Part 1 – This section has some demographic information. Kindly fill all the questions by
either ticking the choices or filling the spaces provided.
Part 2 – In this section you will be asked to provide information on your financial
educational background.
Part 3– You are again required to give information on your participation in the NSE.
Investment procedures you normally use and the types of securities you invest in.
Please answer all questions.
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Section B
Part 1- Demographic information.
1. What is our gender?
A.
B.
Male
Female
2. What is your marital status ?
A.
B.
Married
Single
3. What is your age group ?
A.
B.
C.
D.
E.
20 years or below
21-30 years
31-40 years
41-50 years
51-60 years
4. Are you currently employed?
A.
B.
Yes
No
5. If you answered yes, to the above question, please state your occupation.
6. In which income category do you fall to?
A.
B.
C.
D.
E.
F.
0-50,000 KSHS
51,000-100,000 KSHS
101,000-150,000 KSHS
151,000-200,000 KSHS
201,000-250,000 KSHS
Other
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Section B
Part 2: The following section will gather information on your educational
background.
7. What is your highest level of education you’ve attained ?
A.
B.
C.
D.
E.
Primary level
Secondary level
Undergraduate
Graduate
Post Graduate
8. If you chose C, D or E in the above question, then what was your main field of study?
9. If you chose A or B in the question 7, then where did you gain you financial
education?
A.
B.
C.
D.
E.
Work place
Media
Friends/relatives
Investment groups
Other
10. Has your financial education been useful in helping you invest in the NSE?
A.
B.
Yes
No
11. Kindly propose the easiest way to gain financial knowledge in Kenya?
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Section B
Part 3:The following section will gather information on your investment procedures,
Nairobi Securities Exchange Participation and your choice of investments.
12. Briefly describe your investment procedure in the Nairobi Securities Exchange
(NSE).
13. Do you consult a financial analyst for assistance before investing in the NSE?
A.
B.
Yes
No
14. If you chose B in question 13 above, please explain why?
15. What/Whom do you use for assistance apart from the financial analyst before
making an investment?
A.
B.
C.
D.
E.
Financial statements
Media
Friends
Investment groups
Other
16. Is the choice you made above effective/helpful in making good investment
decisions?
A.
B.
Yes
No
17. Do you make use of a portfolio while investing in the NSE?
A.
B.
Yes
No
18. If you chose A in the above question, then briefly describe your current portfolio.
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19. If you chose B in the above question, then briefly explain why you don’t make use of
a portfolio.
20. How long have you actively invested in the NSE?
A.
B.
C.
D.
1 year.
2 years
3 years
More than 3 years.
21. Would you consider investing in the Nairobi Securities Exchange again?
A. Yes
B. No
22. Would you classify yourself as a long-term or short-term investor?
A.
B.
C.
Long-term investor.
Short-term investor
Depends
23. Do you prefer investing in bonds or stocks and why?
24. Which type of stocks do you prefer investing in?
25. Give any suggestions you may have on how one can be a successful investor in the
NSE.
THANK YOU VERY MUCH FOR YOUR TIME AND CONSIDERATION!!!
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