Financial Literacy and Investment Decision-Making: The Moderating Role of Risk Tolerance

Abstract

Investment decision making is becoming more and more known to depend on the information that is available to investors, but also on their ability to understand and use it; in other words their financial literacy. The present study explored the association between financial literacy and investment decision making and assessed the moderating effect of risk tolerance on the association between financial literacy and investment decision making. Data were collected using a quantitative, cross-sectional survey design, involving purposive sampling of 215 individual investors who have experience in investing in stocks, mutual funds, bonds, savings instruments and other investment products. Partial Least Squares Structural Equation Modeling (PLS-SEM) technique was used for data analysis. The measurement model showed high indicator reliability (all loadings > 0.82), high internal consistency (Cronbach's alpha and composite reliability were both higher than .89), and high convergent and discriminant validity (AVE > .74; Fornell-Larcker and Heterotrait-Monotrait criterion were met). The structural model indicated that FL had a significant and positive relationship with IDM (beta =0.345, p < 0.001) and risk tolerance significantly moderated this relationship (beta =0 .274, p < .001); that is, the positive effect of FL with the IDM increased significantly with an increase in investors' risk tolerance. The complete model accounted for 22.8% of the variance in the investment decision-making, and it was found to have acceptable predictive relevance (Q2 =0 .193). The results enhance behavioral finance theory by demonstrating that financial knowledge is not the only factor important for explaining the quality of investment decisions and that there are boundary conditions that influence the relationship between financial literacy and sound investment decisions: the willingness to endure financial uncertainty. The implications for financial educators, advisors, and policy makers are discussed.