Investor financial literacy, confidence work together to increase stock market participation

While research shows that people who are more financially literate invest their money at higher rates, those who also have greater confidence are more willing to make riskier investments, according to a University of Michigan study.

Set for publication in the November issue of Economic Modelling, the paper used data from the 2019 Survey of Consumer Finances to explore the relationship between investor financial literacy and confidence to determine which had a bigger impact on investor behavior.

The study found that people with both high financial literacy and high confidence in themselves and the economy are more likely to invest in stocks rather than lower-risk investments like bonds—creating more diverse portfolios as a result.

"There's long been a bit of a puzzle about why participation rates in stock markets in the U.S., and around the world, really, are pretty low," said Joanne Hsu, director of the Survey of Consumers at the University of Michigan's Institute for Social Research and one of the paper's four authors.

"Nearly half of American households do not directly own stocks. So we were trying to understand to what extent does financial literacy play into that? To what extent does investor confidence, whether that's confidence in your own ability to manage your finances or confidence in the economy, play into that as well?"

Hsu says that confidence in the economy is much more influential for investing in the stock market than in the bond market.

"And that makes sense because bonds are less risky than stocks. Often you turn to the less risky assets if you think the economy is not doing well," she said. "So it was really heartening to find a very sensible result for confidence."

Hsu and colleagues say that working toward increasing investor confidence—both in their own investment abilities and in the economy as a whole—could lead to greater economic health for families and individuals.