Financial literacy and household asset allocation: Evidence from micro‐data in China

• Published date: 01 December 2021
• Author: Xiaomeng Lu,Jingna Xiao,Yu Wu
• Date: 01 December 2021
• DOI: http://doi.org/10.1111/joca.12406

SPECIAL ISSUE

Financial literacy and household

asset allocation: Evidence from micro-data

in China

Xiaomeng Lu

1

| Jingna Xiao

2

|YuWu

1

1

Survey and Research Center for China

Household Finance, Southwestern

University of Finance and Economics,

Chengdu, China

2

Research Institute of Economics and

Management, Southwestern University of

Finance and Economics, Chengdu, China

Correspondence

Jingna Xiao, Research Institute of

Economics and Management,

Southwestern University of Finance and

Economics, Chengdu, China.

Email: xiaojingna@chfs.cn

Funding information

Higher Education Discipline Innovation

Project, Grant/Award Number: B16040;

National Natural Science Foundation of

China, Grant/Award Number: 72003149

Abstract

Improving household asset allocation (HAA) ability

can enable households to increase consumption and

promote the steady growth of China's economy.

However, HAA decisions in China are suboptimal.

This may be related to households' limited financial

literacy. Based on 2017 and 2019 China Household

Finance Survey data, this study examines the role of

financial literacy in improving HAA. It finds that the

higher the household's financial literacy, the higher

the household's score in the asset allocation evalua-

tion because households with higher financial liter-

acy pay greater attention to economic and financial

news and are more inclined to seek advice from

investment advisors. Further analysis shows that the

optimization effect of financial literacy on HAA is

greater in households that are wealthy, higher edu-

cated, and located in areas with better regional finan-

cial development. In conclusion, helping households

improve their financial literacy is an important step

toward improving HAA ability.

KEYWORDS

financial literacy, household asset allocation, investment

advisor, regional financial development

Received: 30 October 2019 Revised: 9 August 2021 Accepted: 16 August 2021

DOI: 10.1111/joca.12406

© 2021 American Council on Consumer Interests.

1464 J Consum Aff. 2021;55:1464–1488.wileyonlinelibrary.com/journal/joca

1|INTRODUCTION

With Chinese household wealth increasing,

1

an increasing proportion of individuals are coming

to the realization that suitable household asset allocation (HAA) is important. Higher HAA

ability is conducive to household consumption smoothing (Cocco, 2005). Bhamra and

Uppal (2019) find that in a stochastic, dynamic, and general equilibrium economy, the losses

caused by households' financial portfolio deviations are exacerbated by their impact on the vola-

tility of household consumption growth and externalities of investment and growth. Such

amplified losses ultimately have a considerably negative impact on economic growth and social

welfare. Therefore, higher HAA ability is vital to the continuous supply of capital, reform of the

capital market, promotion of national economic growth, and improvement of social welfare.

However, HAA in China is suboptimal from three aspects. First, housing assets account for

a relatively high proportion of household wealth, especially when compared with liquid assets.

In 2019, 66.7% of the assets held by urban households in China were housing assets (from

CHFS 2019 data), far exceeding the 35.3% of households in the United States (from SCF 2019

data). Second, household investment is extremely concentrated: only 10.6% of Chinese house-

holds invest in three or more types of financial investment markets. By contrast, the rate is 61%

for US households (CGB and CHFS, 2018). Third, China's household financial portfolios face

polarized risk. Lu et al. (2017) point out that compared with European countries and the

United States, the risk distribution of China's household financial portfolios is U-shaped, which

indicates that households are either too risk averse or too risky.

One possible reason for these problems is the limited financial literacy of households.

Financial literacy is the primary factor that affects households' investment decisions and diver-

sification (Bernheim & Garrett, 2003; Luigi & Jappelli, 2008; Zeng et al., 2015). However, a lack

of financial literacy is common in China. A survey indicates Chinese households score an aver-

age of 43.5 in relation to knowledge on the most basic financial knowledge, such as inflation,

interest rates, and market risk issues, which is far below the score of households in the

United States (75.3) and the Netherlands (78.8) (CHFS, 2014). Insufficient financial literacy

leads to an insufficient understanding of asset allocation, which affects household wealth

accumulation.

In this study, we construct a comprehensive index to evaluate HAA and analyze its relation-

ship with financial literacy. First, based on the study of Love (2013), we comprehensively con-

sider income status, household burden, property status, and an age-based rule of thumb to

obtain the optimal HAA at different stages of the life cycle. Second, we calculate the distance

between the actual and optimal HAA. Third, we obtain the HAA score using the weighted aver-

age method. The closer the actual distance to the optimal HAA, the higher the score and the

better the HAA. Finally, we examine the role of financial literacy in the rational allocation of

assets.

We use the rule of thumb rather than dynamic programming (Das et al., 2021) to obtain the

optimal HAA for the following two reasons.

2

First, the rule of thumb is easy to implement. It

not only considers a series of factors, such as life cycle, household wealth, and personal prefer-

ences, but is also more objective as well as easy to understand and calculate (Baumol &

Quandt, 1964). Second, this results in merely a moderate welfare loss. According to Love (2013),

by applying the framework to the life cycle problem, the optimal rules of thumb for portfolio

choice based on age lead to merely moderate welfare losses relative to the dynamic program-

ming benchmark. That implies that “rules of thumb may indeed represent a viable alternative

to more sophisticated solutions to portfolio choice”(Love, 2013, p958).

LU ET AL.1465