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Dynamics of Objective and Subjective Financial Knowledge on Financial Behaviour.


Finances are the integral part of everybody's life. No matter what occupation a person has, what his age, gender or education background, he has to manage his finances. The management of the personal finances of an individual not only depends on his socio-demographic factors but host of other factors as well like a person's risk taking capacity, his trust on the financial service providers and the level of his financial knowledge. The buying of financial products is different as compared to buying other consumer products. Most of the times, the financial decisions once taken are difficult to reverse. An individual would get struck with his investment choices for a particular period of time. He cannot change his investment decisions frequently. Therefore, the financial behaviour of the consumer is different from the usual consumer behaviour witnessed. The financial service providers always endeavour to understand the needs of the customer and various factors which affect his financial behaviour. The present study is an attempt to understand the same.

There are many studies which have extensively researched the financial behaviour of an individual. The financial behaviour of an individual is studied using various variables such as sociodemographic variables (Kostakis, 2012; Rajna et al , 2011; Krah et al, 2014; Garmaise, 2010) , attitude variables (Fishbein, 1963; Sarker et al, 2012; Parotta et al, 1998; Funfgeld et al, 2008; Klontz et al, 2011; Loix et al, 2005), knowledge variables (Cole et al, 2012; Woodyard et al, 2017; Hong et al 2010; Robb et al, 2011; Xiao et al, 2013; Courchane, 2005), locus of control (Grable and Joo, 2000; Vanessa et al , 2005), risk taking capacity (Oehler et al, 2009; Earle, 2009) etc. The different variables are shown to be associated with the financial behaviour in different studies. None of the studies are able to take all the factors at one go because of the complexities involved, if all the variables would be taken together. The present study is trying to study the financial behaviour within the boundaries of the variables which are defined.

The main objective of this study is to examine the association between the objective and subjective financial knowledge on the financial behaviour.

Review of Literature

Financial behaviour is studied extensively in various studies. Financial behaviour is defined as the human behaviour relevant to money management (Xiao, 2008). Financial behaviour not only includes planning, making or tracking everyday expenditures but it also comprises strategies associated with long term planning like retirement or estate planning (Lytton et al, 1995).

It is defined as the sum total of cash flow behaviour, credit behaviour, savings behaviour, investment behaviour and other financial experience (Hilgert et al, 2003).

Financial management behaviour is measured on a 5-item scale by Vanessa et al (2005). The five items are controlling spending, paying bills on time, planning for one's financial future, saving money and providing for one's self and family. The financial behaviour was described as the financial practices such as emergency fund, credit report, no overdraft, credit card payoff, retirement account and risk management by an individual in the study conducted by Robb and Woodyard (2011). In another study, financial behaviour was linked with financial capability (Xiao, Chen and Chen, 2013). The financial capability used three set of variables viz., perceived financial capability, financial literacy and perceived financial behaviour.

Education, number of financial dependents, income and risk tolerance are shown to be strongly related to financial behaviour in a study conducted by Joo and Grable (2004). In another study done by Gautam et al (2016), six socio-demographic factors were strongly associated with the financial behaviour. These factors were age, marital status, household annual income, ownership of real estate, duration of investments which an individual is holding and frequency of review of portfolio done by an investor.

There are wide ranges of sources through which knowledge can be acquired. These could be formal education, such as various courses in schools and colleges or seminars and trainings outside the realm of formal education. In the working paper of Cole et al (2012), the effect of formal education on financial behaviour was studied. It was found that education improves the credit scores of individuals and also reduces the probability of declaration of bankruptcy. The person can also acquire knowledge through informal sources like parents, friends and peer group (Keller et al, 1987; Lee et al, 1999).

In a study done by Hogarth et al (2003), it was found that there was a correlation between financial knowledge and behaviour though the direction of the causality is unclear. It was concluded that compared with those who have less financial knowledge, those with more financial knowledge are also more likely to engage in recommended financial behaviours. This correlation does not necessarily mean, however, that an increase in knowledge improves behaviour. Instead, the causality may be reversed in that people may gain knowledge as they save and accumulate wealth, or there may be a third variable, for example, family experiences and economic socialization, that affects both knowledge and behaviour.

In the study done by Hong et al (2010), it was established that consumers with extensive prior knowledge evaluate the product more favourably when their information processing prompts their perception of progress toward a goal and when the information is represented at a high level of construal. The opposite is true with the consumers having low prior knowledge. The past studies have tried to explore the relationship between financial behaviour and financial knowledge. Hilgert et al (2003) done the study to explore the connection between knowledge and behaviour by focusing on four financial management activities: cash flow management, credit management, saving and investment--those who knew more and those who learned from family, friends, and personal experiences had higher index scores. This may indicate that increases in knowledge and experience can lead to improvements in financial practices, although the causality could flow in the other direction--or even both ways.

The strong relationship was determined between financial knowledge and behaviour by Robb et al (2011). One important finding of their research was that objective knowledge though has a significant impact on the financial behaviour, is not the dominant factor. The other important factors which affect the financial behaviour were income, financial confidence and education. The study in Ghana done by Krah et al (2014) concluded that there is a significant relationship between budgeting and educational level, income level and age of households. Hilgert et al (2003) concluded in their study that on the one hand, increase in financial knowledge improves financial behaviour but on the other hand, financial education improves financial behaviour through increased knowledge.

There are few studies which show that the relationship between knowledge and behaviour is more complicated as improved knowledge does not automatically result in improved behaviour (Braunstein et al, 2002). The study done by Borden et al (2008), questioned the link between knowledge and behaviour. It was suggested that whereas student intentions towards more responsible behaviour was improved by greater knowledge, it did not necessarily indicate if the students follow through with their plans. On the other hand, Robb and Sharpe (2009) noted a significant relationship between credit card balance and financial knowledge. The probability of individuals to revolve a balance, to make only the minimum payments or to take cash advances are impacted by the knowledge of an individual.

The financial knowledge was measured in various ways in the past studies. Mugenda et al (1990) measured financial knowledge with an index of 22 items on various aspects of management, including cash and credit management, asset growth, insurance, retirement, and estate planning. The financial knowledge was also measured with the help of true-false test in the financial domains such as cash management, credit management, investments, insurance, retirement and estate planning (Fanslow, Hira, and Titus, 1986; Titus et al, 1989).

Research by Courchane (2005) indicated that self-assessed knowledge was one of the most significant factors in determining financial behaviour. He actually emphasized that self-assessed knowledge matters much more than the 'objective' knowledge. The self-assessed financial knowledge are the basic financial rules of thumb like not to spend more than what is being earned, pay bills on time, and do the basic budgeting. The objective knowledge is all about the ability to understand the discount rates or the intricacies of credit reports. He further concluded that financial knowledge can improve financial behaviour. The study by Robb et al (2011) has shown that relationship between financial behaviour and financial knowledge holds good for both objective and subjective knowledge. Their study find out that objective and subjective financial knowledge have a low level of correlation and both have a significant impact on financial behaviour. The objective and subjective knowledge was described by Xiao et al in his study in 2013. The objective measure usually is a knowledge quiz with questions regarding a specific life domain. The subjective measure refers to consumer self-assessment of their knowledge level regarding a life domain. There is not much research done on the association between objective and subjective knowledge. The earlier researches show that objective and subjective knowledge to have different effects on financial behaviours (Robb et al, 2011; Xiao et al, 2011).

The Present Study

As can be seen from the existing research, there is an association between financial knowledge and behaviour. But none of the studies spoke about the relationship between objective and subjective financial knowledge and its combined effect on the financial behaviour. The present study is an attempt to bridge this gap. The relations between these variables were explored under the umbrella of certain socio-demographic factors which are associated with the financial behaviour of an individual.

Research Methodology

The exploratory research was done to meet the objectives of the study. The questionnaire was prepared and administered to the sample of individuals who were taking investment decisions in their respective households, either singly or jointly. The sampling method chosen was the combination of snowball and judgemental sampling. The reason for choosing this method was that people are not very comfortable sharing their financial investments' information to the strangers. The questionnaire was sent to around 300 individuals in the year 2016. After data validation checks and deleting invalid responses, 269 responses were selected for further analysis.

Financial management behaviour is measured on a 5-item scale (Vanessa and Marlene, 2005). The objective financial knowledge was measured using the two questions developed by Lusardi and Mitchell (2004) and one question developed by Robb and Woodyard (2011). The currency denomination in the questions was changed to meet with Indian sensibilities. These questions were basically measuring the knowledge of an individual about the effects of compound interest; inflation and diversification on their financial investments. In all these questions, correct answers were coded as 1 and all others are assigned a value of 0. These questions are as follows:

a) Compound Interest: Suppose you had Rs 10,000 in a savings account and the interest rate was 4 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

b) Inflation: Imagine leaving Rs10,000 in a savings account paying 4percent interest with no charges. Imagine that inflation is 8percent. If you withdraw the money in a year, will you be able to buy the same amount of goods as if you spent the Rs10,000 today?

c) Diversification: Which of the following investment strategies do you think entails the greatest risk of losing your capital? The options were: Investing in the shares of a single company; Investing in the shares of more than one company; Don't know.

To measure the subjective financial knowledge, the respondent was asked to assess their overall financial knowledge based on a seven point scale (Allgood and Walstad, 2012) with a rating of one being very low and seven being very high. This question essentially measures the respondent's own perception about his financial knowledge.

Sample Characteristics

A range of socio-demographic variables were included in the study like, gender, age, education, marital status, ownership of real estate, financially dependency, occupation, income, duration of investments and frequency of review of portfolio.

The majority of the respondents (49 percent) are in the age bracket of 26-30 years. As the age of the sample is quite young, majority of them have no financially dependent person on them (30 percent). Most of the respondents (49 percent) have attained their graduation. The respondents are equally distributed between business persons and service (34 percent each) while 23percent of the respondents are professionals. The majority of the respondents (64 percent) is earning less than INR 10 lacs per annum. Most of the respondents (59 percent) are married and have real estate (63 percent). As the sample is quite young, around 50percent of the respondents are investing for less than 3 years. The frequency of the review of the portfolio for majority of the respondents is 29 percent.


First and foremost, the result of objective financial knowledge was examined.

It was observed that 65 percent of the respondents have given correct answer of the question related with compound interest, implying that individuals are generally aware about the benefits of compound interest. They know that keeping money in long term and getting the compounded rate of interest would benefit them immensely. But they seem to be unaware of the effects of inflation and how it actually eats into their savings. Only 46 percent of the respondents are able to give the correct answers when they were asked about the effect of inflation on their investments. More worrisome is the fact that around 34percent of the respondents are not at all aware about the effect of inflation. As far as the diversification of the portfolio is concerned, 48 percent respondents have given the correct answer. But here again, around 22 percent of the respondents don't know the benefits of diversification.

Further, it was observed that only 24 percent of the respondents have given the correct answers of all the 3 questions. The alarming part is that 45.6 percent of the respondents have either given only 1 correct response or no correct response at all.

On the other hand, if the results of the subjective financial knowledge would give an altogether different picture. Notwithstanding their poor score in objective financial knowledge, 44.2 percent of the respondents have assessed their subjective financial knowledge between moderately high to very high. If the simple comparison between the answers of subjective and objective financial knowledge, then it is observed that on the one hand, 19 percent of the respondents have not given a single correct answer for the questions measuring the objective financial knowledge. But on the other hand, only 3.7 percent of the respondents have judged themselves as having very low subjective financial knowledge.

This depicts a very peculiar problem. It implies that an individual would think himself of knowing more than what he actually knows. It can lead him to take financial decisions which are not in his own benefit.

The present study further examines the effect of objective and subjective financial knowledge on the financial behaviour. To do this, three hypotheses were formulated as under:

[H.sub.0a]: There is no positive association between objective financial knowledge and subjective financial knowledge.

[H.sub.1a]: There is a positive association between objective financial knowledge and subjective financial knowledge.

[H.sub.0b]: There is no positive association between objective financial knowledge and financial behaviour.

[H.sub.1b]: There is a positive association between objective financial knowledge and financial behaviour.

[H.sub.0c]: There is no positive association between subjective financial knowledge and financial behaviour.

H1c: There is a positive association between subjective financial knowledge and financial behaviour.

The correlation between the various variables are summarised in Table I.

The above table strengthened the fact that there is no correlation between objective and subjective financial knowledge. Infact, objective financial knowledge is not even correlated with the financial behaviour. Among these three variables, the correlation exists only between subjective financial knowledge and financial behaviour.

To further test if the financial knowledge would significantly cause variance in financial behaviour, hierarchical regression was performed between financial knowledge and financial behaviour. The various socio-demographic factors act as control variables in the hierarchical regression. The summary of regression is shown in Table II.

In the hierarchical regression, all the socio-demographic variables were put in the first step and then in the second step, objective financial knowledge and subjective financial knowledge were introduced. The financial behaviour was taken as the dependent variable. After putting the knowledge components in the regression equation, [R.sup.2] change was significant and it was increased to .117. The beta in the above table indicates the relative importance of each variable. It can be seen that out of all the variables, only subjective financial knowledge is coming out to be the most significant factor effecting the financial behaviour of an individual.


The present study is an attempt to understand the relationship between objective financial knowledge, subjective financial knowledge and financial behaviour. It's been observed that although people are aware about the concept of compounding, they are not very clear about inflation and diversification. People seem to be ignorant about the fact that inflation keeps on eroding their savings slowly. A very few respondents' are clear about all the three basic concepts. It implies that low objective financial knowledge is quite ubiquitous with its presence and some urgent steps need to be taken to remove it.

The other aspect of this study is the subjective financial knowledge which measures the respondents' own perception towards his level of financial knowledge. Surprisingly, most of the respondents have the higher level of their perception towards financial knowledge and rated themselves higher on the scale. They feel that they know what is happening in the financial world. They would be probably taking their financial decisions on the basis of their limited knowledge.

Further, the study shows that there is no correlation between objective and subjective financial knowledge. The financial behaviour itself is dictated more by subjective financial knowledge rather than objective financial knowledge. Now, this dichotomy itself is not good for the people to make investments. This implies that person is making the financial decisions only on the basis of what they think is correct rather than what actually is right for their long term future. This can also lead to the overconfidence among the individuals where they feel that they are adequately saving for their financial future but in reality they are not taking care of the important aspects like inflation, diversification etc. This can also lead to the mis-selling of financial products to the gullible investors. When a person does not actually know the basics of the product, they would be dependent on the suggestions of the financial intermediaries. The intermediaries who are selling these financial instruments to the individuals are getting commissions to sell these instruments. This commission varies from instrument to instrument. In some instruments, the commission is much higher as compared to the other instruments. This may instigate the intermediary to sell the financial instrument to an individual which gives him the highest commission, irrespective of the fact whether that product actually suits the investor or not. In the absence of the objective financial knowledge, an individual might not be aware about the long term impact of his financial decisions on his financial future. This may lead an individual into buying the financial product through which he would not be able to meet his financial goals or is not at all required in his portfolio of investments.

Implications and Future Scope

As per the S&P Global Fin lit survey conducted by Gallup in 2014, 76percent of Indian adults are not considered to be financially literate. These people do not understand the key financial concepts like numeracy, risk diversification, inflation and compound interest. The present study also comes with the same conclusion but in addition, it also tells that irrespective of the levels of the objective knowledge, people in general, have higher dergees of subjective financial knowledge. It leads to the peculiar problem for the policy makers. The policy makers not only have to work towards increasing the financial literacy levels of the individuals but also to make them realize the ill effects of the subjective financial knowledge. The holistic programmes regarding the financial literacy need to be developed which helps the individuals to increase their objective as well as subjective financial knowledge. All the stakeholders need to work in tandem so that more and more people become financially literate. The push should come at the institutional level. The basic programmes related to financial literacy should start from school or colleges. The children should be taught the practical and important aspects of investments and not only savings. The corporates should also take initiatives and conduct the regular workshops for their employees regarding the various investment avenues. The various financial institutions and banks should help the corporates in conducting these workshops.

The present study although presents some useful insights have some limitations. It does not examine the effect of financial knowledge on various kinds of financial products. It is quite possible that the impact of knowledge varies with respect to different financial products. It has also not taken into account the risk taking capacity of an individual. Even if the person's knowledge level is high, the financial decision to make investments is dependent upon his risk tolerance as every financial product has different levels of risk associated with them.

The studies in future can examine the effects of financial knowledge with respect to various financial products. It can also examine the impact of risk tolerance along with the financial knowledge on the financial behaviour.


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Shalini Gautam

Assistant Professor, Amity International Business School, Noida.

Kokil Jain

Associate Professor, Amity International Business School, Noida.
Pearson's Correlation among Financial Knowledge and
Financial Behaviour

Variables                       Objective  Subjective  Financial
                                Financial  Financial   Behaviour
                                Knowledge  Knowledge
Objective Financial Knowledge
Pearson Correlation                 1         .072       -.058
Significance                                  .242        .339
Subjective Financial Knowledge
Pearson Correlation               .072         1         -.270
Significance                      .242                   .000 *
Financial Behaviour
Pearson Correlation               -.058      -.270         1
Significance                      .339       .000 *

* Correlation is significant at 0.01 level.

Regression of Financial Behaviour

Variable                          R        [R.sup.2]  [R.sup.2]

Hierarchical Regression           .342       .117     .076
Marital Status
Financially Dependent
Real Estate Ownership
Duration of Investments
Frequency of review of portfolio
Objective Financial Knowledge
Subjective Financial Knowledge

                                  B          Beta     Significant
Hierarchical Regression                                  .001
Constant                          3.242                  .000
Gender                            .170       .079        .235
Age                               -.058      -.117       .127
Education                         -.073      -.052       .388
Profession                        -.083      -.092       .172
Marital Status                    .083       .053        .443
Income                            -.035      -.053       .434
Financially Dependent             .062       .098        .189
Real Estate Ownership             .093       .048        .454
Duration of Investments           .021       .031        .664
Frequency of review of portfolio  .002       .004        .951
Objective Financial Knowledge     -.055      -.021       .724
Subjective Financial Knowledge    -.172      -.246       .000
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Author:Gautam, Shalini; Jain, Kokil
Date:Apr 1, 2019
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