Quantitative Finance

ISSN: 1469-7688 (Print) 1469-7696 (Online) Journal homepage: www.tandfonline.com/journals/rquf20

Financial literacy and portfolio diversification

Margarida Abreu & Victor Mendes

To cite this article: Margarida Abreu & Victor Mendes (2010) Financial literacy and portfolio
diversification, Quantitative Finance, 10:5, 515-528, DOI: 10.1080/14697680902878105
To link to this article: https://doi.org/10.1080/14697680902878105

Published online: 05 Oct 2009.

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Quantitative Finance, Vol. 10, No. 5, May 2010, 515–528

Financial literacy and portfolio diversification

MARGARIDA ABREU*y and VICTOR MENDESz
yCISEP, ISEG, Technical University of Lisbon, Rua Miguel Lupi 20, 1200-725 Lisboa, Portugal
zCMVM, Portuguese Securities Commission, Av. da Liberdade 252, 1056-801 Lisboa, Portugal

(Received 22 December 2006; in final form 25 February 2009)

We use a survey of individual investors disclosed by the Portuguese Securities Commission

(CMVM) in May 2005 to study the impact of investors’ levels of financial literacy on portfolio
diversification. We consider distinct aspects of financial literacy, and control for socio-
economic and behavioral differences among individual groups of investors. Our results
suggest that investors’ educational levels and their financial knowledge have a positive impact
on investor diversification. The information sources used by retail investors to gather
information on markets and financial products also have a significant impact on the number
of different assets included in a portfolio.

Keywords: Applied finance; Behavioral finance; Empirical finance; European financial

markets

1. Introduction some (but not all) aspects of the observed cross-sectional

variation in family portfolio holdings.
Perhaps the one aspect of the data on portfolio choice Recently, in the literature on portfolio diversification,
that is most challenging to traditional theories is the some attention has been paid to information as a key
apparent lack of diversification in the financial portfolio factor determining individual under-diversification.
of individual investors. Investors hold undiversified Investors may not be informed of the existence and
portfolios made up of a limited number of assets characteristics of all available assets and invest only in
(Goetzmann and Kumar 2001, 2005, Guiso et al. 2002). the few that they are aware of or familiar with (Grinblatt
In fact, most investors hold nearly all of their wealth in and Keloharju 2001). They may make a selective choice
domestic assets (French and Poterba 1991), concentrate of investment in information, investing only in a certain
their portfolio in the equity market (Barber and Odean group of assets about which they think they have superior
2000, Goetzmann and Kumar 2001, Barber et al. 2003) information, in order to maximize their investment
and select these stocks mostly on the basis of geographical in information (Coval and Moskowitz 1999, 2001, Hau
or professional proximity (Coval and Moskowitz 1999, 2001), or they may become ‘specialists’ (Nieuwerburgh
Curcuru et al. 2005, Massa and Simonov 2006). and Veldkamp 2004).
In the framework of traditional finance theory, Simultaneously, a group of alternative explanations
important contributions have been made towards explain- draws attention to the fact that the attitude towards
ing why a rational investor may hold a less diversified diversification varies systematically among groups of
portfolio than might be considered optimal. In fact, agents with different characteristics (Shiller et al. 1991).
in the traditional utility maximizing framework, factors Portfolio diversification may vary according to differ-
such as transaction costs (Guiso et al. 2002), institutional ences in investors’ age (DaSilva and Giannikos 2004),
constraints (Banks and Tanner 2002, Eymann and competence (Graham et al. 2005), wealth (Bertaut 1998,
Borsch-Supan 2002, Guiso and Jappelli 2002, Kumar 2005, Massa and Simonov 2006), trading experi-
Rendleman and Shackelford 2003, Campbell 2006) and ence (Nicolasi et al. 2004), occupancy (Christiansen et al.
customs barriers (French and Poterba 1991) can explain 2007) or the environment in which they live (Goetzmann
et al. 2004). The behavioral finance literature provides
important contributions to explain diversification differ-
ences among investors. Vissing-Jorgensen (2003) finds
*Corresponding author. Email: mabreu@iseg.utl.pt that home bias diminishes strongly with investor’s income.
Quantitative Finance
ISSN 1469–7688 print/ISSN 1469–7696 online ß 2010 Taylor & Francis
http://www.informaworld.com
DOI: 10.1080/14697680902878105
516 M. Abreu and V. Mendes
The author also finds that stock-market participation as
well as the number of stocks held strongly increase with
wealth and income. Another example of this phenomenon
is reported by Calvet et al. (2007b). The authors provide
evidence that active rebalancing is more pronounced for
sophisticated households with higher levels of wealth or
income. Seemingly irrational behavior diminishes substan-
tially with investor wealth or with investor sophistication
(Calvet et al. 2007a).
This paper combines these different approaches to
study the diversification behavior of individual investors.
Our starting point is that the quality of the information
used by investors influences their behavior. Moreover,
because investors behave differently, we have to account
for different characteristics that may justify diversification
differences. Finally, we argue that diversification behavior
depends on investors’ capacity to digest all pertinent
financial information, which depends on the respective
level of education and financial knowledge.
The basic question we seek to answer is to what extent
differences in investors’ portfolio diversification behavior
can be explained by differences in their levels of financial
literacy. We control for socioeconomic differences and
behavioral differences among groups of investors and
consider three distinct aspects of financial literacy:
specific financial knowledge, the investors’ educational
level and the sources of information commonly used by
investors as the basis for their financial choices.
For that purpose, we use a very complete database
disclosed by the Portuguese Securities Commission
(CMVM) in May 2005, which includes the results of a
survey aimed at all Portuguese citizens with at least one
bank account. Each questionnaire contains not only
socio-economic information about investors, but also
reveals the type of the assets held, investors’ experience,
their knowledge of financial markets and the sources
of information used in the decision-making process.
Anticipating some of our conclusions, we can state
that, in Portugal, individual investors’ education level,
their specific knowledge of financial markets and pro-
ducts and the information sources they use to gather
information on markets and financial products have a
clear impact on participation and on portfolio composi-
tion, at least as far as the number of different assets it is
composed of is concerned.
This paper makes four contributions. Firstly, we add
to the existing literature on portfolio choice, showing
that the influence of information on financial diversifica-
tion has three relevant dimensions. These are investors’
financial knowledge about products and financial market
rules, their educational level and the sources of informa-
tion that they commonly use as the basis for their
financial choices. In fact, we show that the number of
assets in the portfolio strongly increases with financial
knowledge, education and sources of information.
Secondly, we confirm recent findings in the behavioral
finance literature showing that better off households
yOECD (2005) has recently published a major study of financial education at the international level.
zSee Dougherty (2003) for a discussion of measures of literacy.
typically conform more closely to the predictions of
standard finance theory, and we add to this literature
giving evidence that the educational level of investors and
their social status encourage participation in risky assets
and contribute towards diversification, even after con-
trolling for household income and other socio-economic
differences.
Thirdly, we show that the sources of information used
by investors are also significant in determining the
composition of their portfolios. In particular, we conclude
that the portfolio of an investor using specialized news-
papers as a source of information includes more assets
than the portfolio of an investor that does not get any
information at all. But we also find that the number
of different assets included in the portfolios of investors
that seek help from their bank/account managers is
similar to that of investors that do not seek any
information at all, which is in itself a surprising result.
Finally, our results provide some potentially useful
evidence on investors’ behavior in small financial
markets. Most studies focus on well-developed financial
markets and very little is known about investor profile,
motivations and behavior in smaller and less-developed
markets. By using data from a survey of Portuguese
individual investors we contribute towards bridging
this gap.
The remainder of the paper is structured as follows.
In the next section, we discuss the measures of financial
literacy we use in our work. Section 3 presents the model.
Section 4 discusses the data, describing both the
construction of variables and the estimation procedure
used. Section 5 reports the empirical results. A brief
conclusion follows.
2. Measuring financial literacy
The impact of education on asset composition has been
analysed in terms of portfolio theory (Mayers 1972) and
studied empirically (Bradley and Graham 1988).
However, despite the growing interest and concern
regarding the financial educationy of individual investors,
very little is known about how financial literacy affects
investors’ portfolio diversification and which financial
literacy features best explain investors’ behavior.
Moreover, there is still no single agreed definition of
financial literacy and even less is there a widely acceptable
measure for it.z In this work, a definition is adopted that
is similar to the one used by the FannieMae Foundation
(Vitt et al. 2000): financial literacy is the ability to obtain
information, analyse, manage and communicate about
one’s personal financial situation as it affects one’s
material well-being. This concept reflects the ability
to collect the relevant information, but also that of
differentiating between different financial options, dis-
cussing monetary and financial issues, planning and
answering competently to events affecting daily financial
 Financial literacy and portfolio diversification
decisions, including those linked to global economic
trends.
As such, we consider three dimensions of financial
literacy. The most direct one is the individual knowledge
about financial markets, the way they function, the
products negotiated and their characteristics. Informed
investors who are aware of financial opportunities,
choices and consequences are better positioned to increase
their well-being, thus becoming more responsible and
financially more self-sufficient. But the perspective of
‘investor’s competence’ is also very important (Graham
et al. 2005). In a time of growing economic uncertainty
and ever more complex financial markets, investors
are constantly required to make decisions based on
ambiguous and subjective conditions. Moreover, inves-
tors’ competence is also important insofar as decisions
taken today will affect their and their families’ future.
Consequently, the general level of education is also
fundamental for obtaining a correct perception of
financial information and available opportunities, as
well as being crucial in the decision-making process.
Finally, a certain dimension is linked to the quantity
and quality of financial information that an investor
may gather on a regular basis. From this point of view,
the quality of the sources of information commonly used
by investors is also a crucial element. Better-advised
individual investors, with more and better information
about general financial issues and products, market
agents and new market opportunities, are better posi-
tioned to take superior financial decisions, achieving,
as a consequence, a more efficient and timely wealth
allocation.
In order to measure the financial literacy of individual
investors under this broad definition, we consider three
dimensions of information: the financial knowledge
revealed by investors in their answers to concrete
questions about the financial market, the investors’
educational level (a proxy for investors’ ability to use
the information gathered), and the sources of information
commonly used by investors as the basis for their
financial choices.
3. Model
The central theme of this work is the analysis of the
importance of financial literacy for investors’ behavior,
through the analysis of its impact on portfolio
diversification.
One key variable in this study is the level of financial
knowledge revealed by individual investors (INFOR).
This variable is constructed on the basis of questions
directly geared towards evaluating their level of knowl-
edge about markets and financial products (this metho-
dology is more clearly explained in section 4 below).
We seek to apprehend the general level of financial
knowledge of Portuguese investors and understand the
ySee section 4 for the definition of these variables.
zGraham et al. (2005) use a similar procedure to model a variable relating to investors’ self-evaluation of literacy.
517
extent to which it is possible to identify socio-economic
groups that can be differentiated on the basis of their level
of financial education. Therefore, a group of socio-
economic factors are identified and we seek to analyse
which of these are significantly related to the investors’
level of financial knowledge. Besides investors’ level of
academic education, we also consider gender, age, marital
status, household size, level of income, area of residence,
habitat, social status, and occupation/profession.y
Having this goal in mind, a model is defined in which
the dependent variable is INFOR and the explanatory
variables are the socio-economic ones.z The aim of this
regression is not to establish a cause–effect link between
these variables but rather to use multivariate statistical
techniques to properly identify the socio-economic
characteristics of better-informed investors. So, the
model being used is
X X
INFOR ¼ c þ i Xi þ l EDUl , ð1Þ
i l
where Xi represents the socio-economic control vari-
ables, and EDUl represents the investors’ educational
level.
Since we do not know the exact composition of the
portfolio of each investor, we build up a proxy for the
degree of portfolio diversification based on investors’
responses to their own financial possession. The investor
portfolio diversification variable (PORTFDIV ) is con-
structed by adding the number of different kinds of
financial assets investors reveal they hold in their
portfolio (bank deposits, savings certificates, treasury
bills, stocks, bonds, mutual funds, participation certifi-
cates and derivatives), plus the number of different issuers
of each type (details available in section 4). This measure
corresponds basically to what is known as the 1/N rule
for asset allocation. The 1/N diversification rule simply
means that investors allocate 1/N of their wealth to each
of the N risky assets available for investment.
The number of different assets within a portfolio
is certainly not the perfect measure for identifying the
degree of diversification. As a matter of fact, two
individuals may both hold the same number of stocks
in their portfolios, but one may hold stocks with low
correlations and the other may hold strongly correlated
stocks confined to a single industry—the volatility of
these portfolios will certainly differ. In short, this
diversification measure is frequently seen as overstating
the level of portfolio diversification (Blume et al. 1974,
Vissing-Jorgensen 1999, Goetzmann and Kumar 2005).
Recent research, however, concludes that this appar-
ently naı̈ve 1/N allocation rule is far from being an
inefficient strategy and therefore the number of different
securities in a portfolio can be seen as a useful heuristic
method for identifying the degree of diversification.
According to the findings of DeMiguel et al. (2005),
when compared with several static and dynamic models
of optimal asset allocation, this rule appears to have
518 M. Abreu and V. Mendes
a higher out-of-sample Sharpe ratio, a higher certainty-
equivalent return and a lower turnover than optimal asset
allocation strategies.
In order to evaluate the importance of financial literacy
on individual investors’ portfolio diversification behavior,
we consider the above-mentioned three dimensions of
information: the financial knowledge, the investors’
educational level and the sources of information used
by investors.
Besides these central variables, we control for other
factors possibly conditioning investors’ behavior. The
investors’ choice of which assets to have in a portfolio can
be influenced by the quality of the market and its different
segments. It is necessary, for instance, for the various
types of assets to be negotiated in well-developed, liquid
markets if they are to become effective investment
alternatives. Thus, besides the socio-economic variables
already discussed (used as control variables), we also
include as variables designed to explain portfolio diversi-
fication the investors’ individual evaluation of the overall
quality and the overall risk level of the Portuguese
market.
It is also important to control for some of the specific
characteristics of individual investors. We expect more
experienced investors, those more used to financial
matters, to be more skilled at handling a diversified
portfolio than investors who are newcomers to the
market. Market experience is therefore introduced as an
explanatory variable. Being in the market longer means
that, in general, investors have enjoyed success (otherwise
they would have left) and the greater their success, the
greater the confidence of investors in their own abilities
and the greater their portfolio diversification: when
investors feel confident in their ability to understand the
risks and benefits linked to financial investments, they
are able to invest in new assets, thus diversifying their
portfolios (Graham et al. 2005).
The investor profile, given by individual investment
styles, may also be relevant in their choice of financial
assets. Investors that are more active, those that more
frequently review the assets that they hold, i.e. those
whose assets are held for shorter periods, are considered
by traditional finance theory to be those that accept
a greater risk, so that this could be linked to a higher
concentration of assets in the portfolio (Brennan et al.
1997, Campbell and Viceira 1999). This idea derives from
the concept of dynamic diversification, according to
which, generally speaking, above-average returns tend
to compensate for below-average returns if the investment
time span is long. On the other hand, and looking
at behavioral finance, the investment time span of
individuals affects their own perception of risk and,
consequently, their portfolio diversification. Investors
that reveal a myopic refusal to accept losses are more
prone to accepting risks (and therefore diversify less)
if they evaluate their portfolio less frequently (Thaler
et al. 1997). The fact that individuals are more sensitive
yQuestions related to financial knowledge, sources of information and market experience were only asked to the sub-set of investors.
to losses than to gains (disposition effect), together with
the cognitive error of equating low probability with null
probability (mental accounting), are additional arguments
that converge to conclude that investors accept more
risk (diversify less) if they revise their portfolio less often.
Thus, individual investors’ portfolio diversification is
analysed through the following model:
X X
PORTFDIV ¼ c þ i Xi þ j Xj þ INFOR
X X
þ l EDUl þ k INFSk , ð2Þ
where Xi represents socio-economic control variables,
Xj represents other control variables, INFOR represents
investors’ financial knowledge, EDUl represents investors’
educational level, and INFSk represents the sources of
information commonly used by investors.
However, the diversification variable is only relevant
for participants in the stock market. This means that there
is a potential self-selection bias arising from limited
participation. Thus, we assume a Heckman (1979)
selection model, the selection equation being
X
I¼ 0þ i Xi , ð3Þ
where I is a binary variable, equal to 1 if the respondent
is an investor (i.e. is a participant in the stock market),
and 0 if the respondent is not an investor, and Xi
represents the socio-economic control variables.
4. The database and the variables
CMVM has undertaken several surveys to identify the
profiles of individual investors. The original databases of
two of those surveys were publicly disclosed in May 2005.
The present study uses the 2000 database, which is the
most recent one.
The 2000 survey was addressed to Portuguese citizens,
residing on the Portuguese mainland, in the Azores and
in Madeira, aged over 18 and with at least one bank
account. CMVM, BVLP and Interbolsa workers were
excluded. A total of 15 039 contacts were made between
2 October and 22 December 2000, stratified by region
and habitat. The direct interview technique was used, and
simple questions related to socio-economic matters and
securities’ ownership were asked. The contacts made
allowed for the identification of 1559 investors in
securities. An investor in securities is one holding one or
more of the following assets: stocks, bonds, mutual
funds, participation certificates and derivatives. All
these investors were then interviewed using a structured
questionnaire.y Overall, 1268 investors completed the
questionnaire (although some investors may not have
answered all questions). Those questioned were indivi-
duals who were responsible or co-responsible for family
investment decisions.
Each questionnaire is composed of four parts. The first
contains information of a socio-economic nature: gender,
 Financial literacy and portfolio diversification 519

marital status, age, educational level, profession, income Table 1. The sample variables.
and place of residence. The second includes information Standard
Mean Total Answers
relating to the nature and type of the assets held,y deviation
experience and type of investor (short-, medium-or long-
term). The third part refers to investors’ information S_BANK 0.542 0.498 672 1240
S_FRIENDS 0.152 0.360 189 1240
about markets and their agents, sources of information S_SPECIALIZED 0.268 0.443 332 1240
used and their evaluation of various aspects related to the S_PRESS 0.202 0.401 250 1240
Portuguese securities market. Lastly, the fourth part S_TV/RADIO 0.456 0.498 565 1240
refers to information about investors’ behavior: frequency S_BULLETIN 0.114 0.318 141 1240
S_NONE 0.120 0.094 149 1240
of transactions and information gathering, investors’
MARKEVL 3.969 0.913 na 1065
concerns about the securities market and their criteria MARKRISK 4.684 1.237 na 1208
for selecting assets. TREX1 0.105 0.307 130 1234
Notwithstanding its importance in terms of investors’ TREX2 0.254 0.436 314 1234
literacy, investors’ educational level in general is not a TREX3 0.442 0.497 545 1234
TREX4 0.199 0.399 245 1234
good proxy for assessing their level of education
INV_VERY SHORT 0.056 0.230 69 1236
regarding financial matters.z In fact, unless their educa- INV_SHORT 0.241 0.428 298 1236
tional training is specifically directed to financial matters, INV_MEDIUM 0.472 0.499 584 1236
most of the Portuguese curriculum does not include issues INV_LONG 0.231 0.421 285 1236
related to securities markets, their agents and instru- GENDER 0.689 0.463 874 1268
AGE 41.59 14.28 na 1263
ments. It is therefore necessary to find a better proxy
MARRIED 0.715 0.452 906 1268
for investors’ financial knowledge. FAMSIZE 3.091 1.215 na 1264
The survey makes it possible to build up such a proxy. ED_UNIV 0.326 0.469 412 1263
Three of the questions are particularly useful for attaining ED_HIGH 0.470 0.499 594 1263
this goal. These are question 7, question 11 (combined ED_LESS THAN HIGH 0.203 0.400 257 1263
INC_LOW 0.745 0.492 745 1000
with 11A) and question 13. In question 7, investors are INC_MEDIUM 0.121 0.326 121 1000
asked to name companies with shares or bonds listed, up INC_MED/HIGH 0.075 0.264 75 1000
to a maximum number of five. Responses to this answer INC_HIGH 0.059 0.236 59 1000
are marked from 0 to 5, with 0 meaning that investors PORTO 0.110 0.314 140 1268
fail to mention the name of any company and 5 meaning LISBON 0.222 0.416 282 1268
OTHER 0.667 0.471 846 1268
that they refer to the name of five companies with shares CEO 0.212 0.409 269 1267
or bonds listed. In question 11A (and in question 11) UNSKILLED 0.253 0.435 320 1267
investors are asked whether they know any of the DIRECTOR 0.328 0.470 415 1267
following entities: BVLP, Interbolsa, CMVM, Credit INACTIVE 0.108 0.311 137 1267
Institutions, Dealers. Again, the answers are marked from INDEP 0.099 0.299 126 1267
ST_HIGH 0.163 0.369 206 1262
0 to 5, with 0 meaning that investors are unaware of these ST_INTERMEDIATE 0.675 0.468 856 1262
entities and 5 meaning that they know them all. Finally, ST_LOW 0.158 0.365 200 1262
question 13 is as follows: ‘‘If you wish to file a complaint
about a financial intermediary, an issuer or any other The sum of the variables S_BANK to S_NONE is more than 1240 since
investors could select more than one information source. The number
entity related with the securities markets, to whom would of respondents in each group of variables is not the same, because not all
you address it?’’ Answers are marked with 5, if CMVM investors answered all the questions.
is mentioned, and with 0 if any other entity is mentioned,
or if no entity at all is identified.
The INFOR variable is the simple arithmetical average of the assets included and their precise weight), one must
of the answers obtained to questions 7, 11A and 13 and find a suitable proxy for diversification. Questions 1,
will be used as the proxy for the financial knowledge 2 and 2b are useful for achieving this aim. In question 1,
of individual investors. INFOR varies between 0 and 5, investors are asked to identify the financial assets they
higher values indicating a better understanding of own (bank deposits, savings certificates, treasury bills,
financial markets. securities and other financial assets). In question 2,
A very significant number of investors (21.29%) have investors reveal the type of securities included in the
very limited specific knowledge (INFOR  1) and only portfolio (stocks, bonds, mutual funds, participation
11.36% of investors have sound knowledge (INFOR  4) certificates and derivatives). In question 2b, investors
(table 1). About two-thirds of investors (71.61%) exhibit claiming to hold stocks are asked to identify the names
what we can class as negative knowledge (INFOR52.5). of the issuers of such stocks. We create the PORTFDIV
As previously stated, a better understanding of variable as a proxy for diversification, assuming that each
securities markets can result in lower portfolio risk, different type of asset and/or security and/or issuer
through diversification. In the absence of exact informa- contributes to portfolio diversification and therefore
tion on each individual investor portfolio (both in terms similarly reduces the risk. Thus, for each investor,

yUnfortunately, there are no questions related to the size of the portfolio, nor the amounts invested in each type of asset.
zVan Rooij et al. (2007) present recent evidence on this subject.
520 M. Abreu and V. Mendes

PORTFDIV equals the number of different kinds of
assets, plus the number of different types of securities
plus the number of different issuers of each type investors
hold in their portfolio.y
PORTFDIV ranges from 1 to 11, meaning that the
most diversified portfolio has 11 different assets/secu-
rities/issuers. On average, each portfolio comprises 2.6
assets/securities/issuer (the median is 2), but a significant
number of investors hold only one security/issuer. This
contrasts with the findings of Barber and Odean (2000)
for the United States: a typical American investor has
a portfolio of four issuers (the median being three).z
This means that most Portuguese investors’ portfolios
are under-diversified.x As regards the types of assets
investors hold, 87.2%, 6.2%, 12.1%, 4.1% and 0.9% hold
stocks, bonds, mutual funds, participation certificates
and derivatives, respectively. On the other hand, 11.4%
hold savings certificates or treasury bills and 38.2% hold
bank deposits.
The MARKEVL variable summarizes investors’ eva-
luation of some of the characteristics of the Portuguese
securities market that may influence their behavior.
Question 9 of the survey requests investors to classify
the securities markets in Portugal, on a scale ranging from
1 (low) to 7 (high), in relation to the following
characteristics: ‘easy access’, ‘liquidity’ and ‘level of
development’. MARKEVL was calculated as the simple
arithmetical average of the scores attributed to these
three characteristics. MARKEVL ranges from 1 to 7, with
higher values meaning a better evaluation. The sample
mean of this variable is 3.97, and the standard deviation
is 0.913.{
Another market characteristic that may also influence
investors’ behavior towards diversification is the evalua-
tion of the market risk. Thus, if the market is considered
too risky, this may rationally lead investors who are
less prone to accepting risks to greatly diversify their
portfolios. The MARKRISK variable is based on ques-
tion 17: ‘‘How would you classify the risk of the
Portuguese securities market on a scale from 1 (very
low) to 7 (very high)?’’. This variable thus evolves from
1 to 7, its sample mean is 4.68 and the standard deviation
is 1.24 (1208 respondents).
Three additional characteristics are considered in our
analysis: the information sources used by the investor,
investors’ experience in the securities market and their
respective investment styles. As far as the information
sources that investors commonly resorted to when
wishing to obtain information about the securities
market were concerned, the following were mentioned:
(1) bank/account manager; (2) friends/family/colleagues;
(3) specialized newspapers; (4) other written press;
(5) television/radio; (6) stock exchange bulletin of
quotations; (7) none. The variables S_BANK,
S_FRIENDS, S_SPECIALIZED, S_PRESS, S_TV/
RADIO, S_BULLETIN and S_NONE are, therefore,
seven dummy variables, taking the value of 1 when
investors stated that they had used source j ( j ¼ 1, . . . ,7)
to obtain information about the securities market.
In order to measure experience, the following question
was used: ‘‘how long have you been investing in the
securities market?’’ The answers were marked as: (i) less
than a year, (ii) between 1 and 2 years; (iii) between
2 and 5 years; and (iv) 5 years or more. TREX1, TREX2,
TREX3 and TREX4 are dummy variables, taking the
value of 1 if the investor has been investing for less than
1 year, for between 1 and 2 years, for between 2 and
5 years, or for over 5 years, respectively.
Finally, in terms of their investment style, investors
were classified as follows: (1) very short-term, when
holding their assets for a maximum period of one month;
(2) short-term, when holding their assets from one month
to one year; (3) medium-term, when holding their assets
from 1 to 3 years; and (4) long-term, when holding their
assets for more than 3 years. Accordingly, the variables
INV_VERY SHORT, INV_SHORT, INV_MEDIUM
and INV_LONG are binary variables, taking the value
of 1 depending on whether the respondent was a very-
short term, short-term, medium-term or long-term
investor, respectively.
The socio-economic variables are the following.
(1) GENDER: binary variable, equal to 1 if the
investor is a male or 0 if female.
(2) AGE: investor’s age, in years.
(3) MARRIED: binary variable, equal to 1 if married
or living in a de facto union.
(4) FAMSIZE: number of persons in the household.
(5) Maximum educational level. This variable is
considered under three categories: ED_UNIV ¼ 1,
if the maximum educational level is an intermedi-
ate or university degree; ED_HIGH ¼ 1, if the
maximum educational level is the 9th or 12th
grade; and ED_LESS THAN HIGH ¼ 1, if the
maximum educational level is below the 9th grade.

yAs such, it is assumed that each different asset/security/issuer makes the same contribution to diversification. Different definitions
for this variable are discussed later in the paper.
zBarber and Odean (2000) only report different shares of different issuers, whereas we report the total number of assets, thus
including shares and other securities.
xNonetheless, under-diversification does not always mean sub-optimal behavior. Economies of scale in obtaining and dealing with
information may lead investors to specialize in a certain number of assets or in assets that are closely correlated (Nieuwerburgh and
Veldkamp 2004). But, as their knowledge of these assets increases, these become less risky to that investor. This is a case of conflict
between the benefits of specialization and those of diversification, where a less diversified portfolio does not necessarily mean a sub-
optimal choice. The rationality of such behavior is supported by studies such as the one undertaken by Ivkovic et al. (2004), where,
on average, those families that concentrate their financial investments in a small number of assets achieve better results than families
that greatly diversify their portfolios.
{A binary variable, MARKEVLMISS, was also defined. It is equal to 1 if the investor did not answer these questions related to the
characteristics of the securities market.
 Financial literacy and portfolio diversification 521

(6) Net annual household income. Four categories Table 2. Model (1) estimation results.
are considered: INC_LOW ¼ 1, if net annual Variable Coefficient t-Stat
household income is below 24 938 E; INC_
MEDIUM ¼ 1, if equal to or above 24 938 E, Const. 0.632 1.89*
GENDER 0.597 8.77***
but below 37 410 E; INC_MED/HIGH ¼ 1, if
AGE 0.042 3.00***
equal to or above 37 410 E, but below 49 880 E; AGE  AGE 0.001 3.23***
and INC_HIGH ¼ 1, if net annual household MARRIED 0.205 2.50**
income is above 49 880 E.y FAMSIZE 0.034 1.22
(7) Investor’s area of residence. Three geographical ED_UNIV 0.504 3.68***
ED_HIGH 0.230 2.03**
locations are considered: PORTO ¼ 1, if living in INC_MEDIUM 0.248 2.32**
the Porto metropolitan area; LISBON ¼ 1, if INC_MED/HIGH 0.047 0.34
living in the Lisbon metropolitan area; INC_HIGH 0.151 0.98
OTHER ¼ 1, if living elsewhere.z INCMISS 0.315 4.10***
(8) Investor’s occupation. Five categories are con- LISBON 0.084 0.93
PORTO 0.282 2.37**
sidered: CEO ¼ 1, if the investor is the owner/ H_MEDIUM 0.055 0.54
boss; DIRECTOR ¼ 1, if the investor is a senior H_BIG 0.007 0.07
or middle manager, or if the investor’s profession ST_INTERMEDIATE 0.023 0.24
is a technical, scientific or artistic one; ST_LOW 0.334 2.04**
INDEP ¼ 1, if the investor is a liberal professional CEO 0.004 0.03
DIRECTOR 0.036 0.28
or an independent worker; UNSKILLED ¼ 1, INDEP 0.450 3.11***
if the investor is an office clerk, semi-skilled UNSKILLED 0.224 1.91*
or unskilled worker; and INACTIVE ¼ 1, if the
The dependent variable is INFOR and the model was estimated by OLS.
investor is inactive (student or unemployed).
The number of observations is 1255, and R2 ¼ 0.179. Significant at the
(9) Investor’s habitat. The survey considers three ***1%, **5% and *10% significance level.
types of habitat, scored as follows:
H_SMALL ¼ 1, if the investor lives in a location
of up to 4999 inhabitants; H_MEDIUM ¼ 1, if the 5. Results
investor lives in a location of between 5000 and
19 999 inhabitants; H_BIG ¼ 1, if the investor 5.1. Investors’ financial knowledge
lives in a location of 20 000 or more inhabitants. As already mentioned, the INFOR variable is used in this
(10) Investor’s social status. We consider three cate- study as an indicator of the specific level of information
gories: ST_HIGH ¼ 1, if the investor has a type A shown by investors about matters of a financial nature.
status (the highest); ST_INTERMEDIATE ¼ 1, In order to find out whether there is a typical investor’s
if the investor has a type B or C status (that is, profile for the different levels of financial knowledge,
an intermediate social status); ST_LOW ¼ 1, Model (1) is estimated by the ordinary least squares
if the investor has a type D or E status (E is the method. The results are shown in table 2. It is interesting
lowest).x to note the following.
The sample is quite diversified (see table 1). In fact, the (a) Men are better informed than women.
number of investors in each category is reasonably high. (b) Married investors or those living in a de facto
For example, 672 investors claimed to look for informa- union are less well-informed.
tion about the market with their bank or account (c) The level of information is at its highest in
manager, and 149 stated that they did not use any investors of around 43 years of age.
source of information whatsoever. On the other hand, (d) Investors’ financial knowledge is greater if they
130 investors claimed to have been investing for less than have completed an intermediate or university
one year, and 285 said that they had had their assets degree.
for more than three years. (e) Investors’ financial knowledge is higher if they
In short, the survey contains information referring have an intermediate income level.
to 1268 investors, although they may not have answered (f) The region matters: investors located in the Porto
all questions. As is the case in most surveys, the questions metropolitan area (the second largest city) reveal
relating to the household income level were the ones better knowledge.
that received fewest answers (in this case, only 1000 (g) Habitat is not relevant, but investors with lower
responses). status are less informed.

yINCMISS was also defined. It is equal to one if the respondent did not answer the income-related question.
zWe speculate that investors located in the big cities (Lisbon and Porto) have access to more and better quality information than
investors who reside in the countryside, and as such diversify more.
xThe social status variable is based on the education and occupation variables. For example, owners, senior and middle managers,
independent workers, with an intermediate or university degree are included in the highest status. On the other hand, unskilled
workers with less than 4 years of schooling are included in the lowest status. Thus, status could be related to wealth but cannot be
assumed a perfect proxy for wealth.
522 M. Abreu and V. Mendes

(h) Liberal professionals and non-specialized employ- Table 3. First stage selectivity model estimates.
ees have a higher level of information. Variable Coefficient z-Stat
The influence of these variables is particularly evident Const. 2.473 12.83***
in the quartile of better informed investorsy (i.e. in the GENDER 0.356 9.02***
4th quartile of the INFOR variable). In the first three AGE 0.031 4.13***
quartiles, there are no significant differences to be AGE  AGE 0.0003 3.98***
pointed out. MARRIED 0.014 0.32
FAMSIZE 0.035 2.38**
ED_UNIV 0.661 8.41***
5.2. The importance of financial literacy ED_HIGH 0.372 6.27***
INFOR_HIGH 0.151 2.43**
Model (2) is used to uncover the importance of financial INC_MEDIUM 0.424 5.65***
literacy for the portfolio diversification of individual INC_MED/HIGH 1.147 9.39***
investors. The dependent variable (PORTFDIV ) assumes INC_HIGH 1.278 8.66***
only non-negative integer values, as it is a count model. INCMISS 0.093 2.10**
LISBON 0.113 2.26**
However, this measure of diversification only makes sense PORTO 0.062 1.06
for investors (respondents who participate in the financial H_MEDIUM 0.209 3.65***
market). Thus, we correct for potential self-selection bias H_BIG 0.084 1.83*
coming from limited participation in the stock market. ST_INTERMEDIATE 0.026 0.38
We estimate a Heckman (1979) two-stage selection model ST_LOW 0.299 3.03***
CEO 0.324 4.25***
in order to account for the correlation between the error UNSKILLED 0.225 3.81***
term in Model (2) and in the selection equation (3).z DIRECTOR 0.051 0.74
Hence, in the first stage we estimate the Probit Model (3) INDEP 0.198 2.43**
and in the second stage we estimate Model (2) assuming
The dependent variable is I (dummy variable, equal to 1 if a participant).
a Poisson distribution. The restrictions on the Heckman
The model was estimated by ML, with 14,469 observations.
procedure are the variables related to the sources of Log L ¼ 3151.1 and restricted Log L ¼ 3851.4. Significant at the
information, investment style, market experience, evalua- ***1%, **5% and *10% significance level.
tion and risk. These variables are not available for non-
investors.
higher income and higher social status. But they also
5.2.1. Financial literacy and the decision to participate in show that investor’s levels of financial knowledge and
the stock market. Model (3) allows us to study the many education are very relevant for stock market participa-
determinants of ownership of risky assets. However, the tion, even after controlling for a wide range of socio-
financial knowledge variable is only available for economic characteristics.
participants insofar as non-participants were not asked
the survey questions 7, 11 and 13 (see section 4).x
We make the (strong) assumption that the financial 5.2.2. Financial literacy and portfolio diversification. The
knowledge profile of participants and non-participants is second stage regression corrects for the fact that some
similar. Thus, we apply the estimates of the socio- respondents do not participate in the stock market.
economic variables exhibited in table 2 to estimate the Model (2) is estimated in the second stage, using
level of financial knowledge of non-participants. We then information on investors. However, given that we have
define a new variable, INFOR_HIGH, that is equal to investors’ answers to survey questions 7, 11 and 13, we
1 for the top quartile of the estimated levels of knowl- use the INFOR variable, not the INFOR_HIGH used in
edge,{ and include this variable among the set of the first stage regression. Considering the characterization
explanatory variables in (3). The results of the first of the INFOR variable and in order to avoid multi-
stage selectivity model are shown in table 3. collinearity, Model (1) estimation residuals (INFORR) are
Our estimates confirm previous findings in behavioral used in Model (2). By construction, INFORR is orthogo-
finance which associate increased participation with nal to the socio-economic variables.yy

yThese results are not reported, but are available from the authors upon request.
zSee Wooldridge (2002), for example, in the context of count models.
xWe use the terms ‘investor’ and ‘participant’ interchangeably. Thus, an individual participates in the stock markets if he/she holds
one or more of the following assets: stocks, bonds, mutual funds, participation certificates and derivatives.
{Results with a smaller set of ‘literate’ individuals are very similar and thus are not reported; they are available from the authors
upon request.
yyParticipation in the stock market may help investors to learn and improve their respective knowledge of financial market matters,
thus creating an endogeneity problem. Since we do not have any information on the levels of financial literacy that are truly
exogenous vis-à-vis financial behavior, we might end up with biased estimators. Van Rooij et al. (2007) faced a similar problem and
found that the bias is not relevant enough to change their results and conclusions. It is also possible that the investment horizon
variables could be endogenous regressors. However, they are not significant. If we re-estimate the model omitting INV_VERY
SHORT, INV_SHORT and INV_MEDIUM, the estimated coefficients of the remaining variables are essentially unchanged (results
not shown, but available from the authors upon request), and we conclude that if endogeneity exists it does not seem to bias our
results.
 Financial literacy and portfolio diversification 523
Table 4. Model (2)—second stage estimates. into two. On the one hand are the sources that contribute
Variable Coefficient z-Stat towards an increase in diversification. This group includes
specialized newspapers (S_SPECIALIZED) and the
Const. 0.152 0.46 stock exchange bulletin of quotations (S_BULLETIN),
GENDER 0.160 3.06*** but also the advice of friends, colleagues and family
AGE 0.002 1.28
MARRIED 0.022 0.50 (S_FRIENDS). The other group is comprised of non-
ED_UNIV 0.283 2.96*** relevant sources, such as the other written press
ED_HIGH 0.163 2.41** (S_PRESS), radio and television (S_TV/RADIO) and
INC_MEDIUM 0.134 1.84* advice from the bank/account manager (S_BANK ).
INC_MED/HIGH 0.004 0.04
In other words, collecting information from the bank/
INC_HIGH 0.161 1.30
INCMISS 0.019 0.38 account manager on issues related to the securities market
LISBON 0.052 0.09 does not seem to significantly contribute towards an
PORTO 0.183 2.73*** increase in portfolio diversification. Both those who do
H_MEDIUM 0.052 0.81 not collect any information and those who collect
H_BIG 0.127 2.61***
information from the account manager behave similarly
ST_INTERMEDIATE 0.079 1.35
ST_LOW 0.127 1.36 in terms of diversification, having on average less
CEO 0.238 2.60*** diversified portfolios.
DIRECTOR 0.066 0.82 If we combine these three different aspects of financial
INDEP 0.173 1.86* literacy, we conclude that the portfolio of an educated
UNSKILLED 0.010 0.14
INFORR 0.067 3.85***
investor with high specific financial knowledge and using
S_BANK 0.026 0.69 specialized newspapers as a source of information
S_FRIENDS 0.228 4.85*** includes on average 0.8 more assets than the portfolio
S_SPECIALIZED 0.164 3.90*** of an investor with less than 9 years of education, very
S_PRESS 0.028 0.64 low specific financial knowledge and that does not get any
S_TV/RADIO 0.038 0.99
S_BULLETIN 0.118 2.31**
information at all. Although seemingly trivial, this
MARKEVL 0.056 2.30** represents 30% (40%) of the average (median) number
MARKEVLMISS 0.139 1.25 of assets in the portfolio.
MARKRISK 0.001 0.03 As far as market characteristics are concerned, ‘access,
TREX2 0.109 1.58 liquidity and level of development’ (the MARKEVL
TREX3 0.306 4.35***
TREX4 0.485 5.87*** variable) also contribute towards increasing portfolio
INV_VERY SHORT 0.117 1.33 diversification. Two possibilities appear in opposition to
INV_SHORT 0.090 1.56 one another here. A more easily accessed, more liquid and
INV_MEDIUM 0.044 0.91 more highly developed market attracts more investors,
MILLS RATIO 0.020 0.19 who invest in more assets. But those very same
Dependent variable: PORTFDIV. Poisson regression—maximum like- characteristics can also lead investors to engage in riskier
lihood estimates. Covariance matrix corrected for clustering (using behavior. In fact, a more easily accessed, more liquid and
location variables). Number of observations: 1084. Significant at the more highly developed market may give investors greater
***1%, **5% and *10% significance level. confidence and encourage them to diversify less, as they
remain aware of the possibility of easily quitting the
Model (2) estimates are shown in table 4. There we can market in a crisis situation. Our results suggest that
see that the Mills ratio is not statistically significant, the first effect is stronger than the second one.
meaning that selectivity is not important. Curiously, investors’ evaluation of the risk of the
The most important result is that, in view of all the Portuguese securities market (MARKRISK ) is not a
aspects considered, financial literacy does indeed matter. determining factor of diversification. In other words, the
Specific financial knowledge shown by investors about fact that only 4% of investors classified the Portuguese
matters relating to the securities markets, measured by market risk as low (MARKRISK ¼ 1 or 2), whereas 25%
the INFORR variable, contributes towards an increase in classified it as high (MARKRISK ¼ 6 or 7) does not seem
the number of assets in the portfolio. Features relating to have had an impact on the composition of investors’
to the educational level of investors are also important for portfolios.
understanding their attitude towards diversification. Thus, In contrast to the above findings, investors’ experience
it can be concluded that investors with an intermediate (TREX ) contributes towards diversification. Therefore, it
or university degree (and even those with the 9th or the can be concluded that the greater the investors’ experience
12th grade) hold a higher number of assets in the portfolio. the higher the number of assets in the portfolio.
This means that the level of education contributes towards Respondents who had invested in the securities market
increasing diversification and therefore decreasing the for more than 5 years were those who had more
portfolio risk. In other words, both at a general level of diversified portfolios. It was not possible to obtain
education and a specific level of expertise, the investor’s information relating to the amount (and volume) of
financial literacy is a positive factor in decreasing risk. transactions effectively carried out by investors in order
Finally, as far as the sources of information are to infer whether the reported experience effect resulted
concerned, we conclude that these sources can be grouped from a greater actual experience in transactions or from
524 M. Abreu and V. Mendes
Table 5. Model (2)—second stage estimates with alternative dependent variables.
Dependent variable

PORTFDIVA (1) STOCKT (1) MUTUAL (2)

Const. 0.019 0.340 0.092

GENDER 0.251*** 0.213*** 0.061**
AGE 0.002 0.000 0.000
MARRIED 0.009 0.006 0.003
ED_UNIV 0.348** 0.265** 0.066*
ED_HIGH 0.175 0.122 0.022
INC_MEDIUM 0.234 0.148* 0.082**
INC_MED/HIGH 0.084 0.042 0.042
INC_HIGH 0.363 0.184 0.143**
INCMISS 0.102 0.058 0.047*
LISBON 0.051 0.117* 0.042
PORTO 0.165 0.133* 0.020
H_MEDIUM 0.088 0.048 0.026
H_BIG 0.046 0.005 0.023
ST_INTERMEDIATE 0.019 0.161** 0.024
ST_LOW 0.099 0.134 0.091
CEO 0.188 0.272*** 0.002
DIRECTOR 0.122 0.110 0.041
INDEP 0.179 0.218** 0.021
UNSKILLED 0.057 0.047 0.027
INFORR 0.052* 0.077*** 0.001
S_BANK 0.030 0.014 0.006
S_FRIENDS 0.189*** 0.190*** 0.003
S_SPECIALIZED 0.175*** 0.142*** 0.027
S_PRESS 0.044 0.009 0.006
S_TV/RADIO 0.104* 0.051 0.065***
S_BULLETIN 0.092 0.070 0.006
MARKEVL 0.023 0.021 0.008
MARKEVLMISS 0.052 0.067 0.026
MARKRISK 0.024 0.021 0.013*
TREX2 0.108 0.133* 0.074**
TREX3 0.131 0.361*** 0.042
TREX4 0.385*** 0.417*** 0.037
INV_VERY SHORT 0.178 0.097 0.050
INV_SHORT 0.121 0.074 0.026
INV_MEDIUM 0.036 0.068 0.001
MILLS RATIO/LAMBDA(3) 0.248 0.038 0.112*

(1) Poisson regression, estimated by maximum likelihood. (2) Sample selection model, estimated by two-stage
least squares. (3) LAMBDA in the last column. PORTFDIVA is equal to the number of different assets
(excluding mutual funds) þ 8  MUTUAL. STOCKT is equal to the number of different stocks in the portfolio.
MUTUAL is a binary variable, equal to 1 if the investor holds a mutual fund. Significant at the ***1%, **5%
and *10% significance level. Covariance matrix corrected for clustering. Number of observations: 1084.

the acquisition of assets at different moments in time,
which are then ‘stored’ as the investor does not need
liquidity. Consequently, this remains an issue that
requires further research.
The investors’ style of investment (the average time
investors keep assets in their portfolios) does not seem to
have an impact on diversification. Finally, as far as socio-
economic variables are concerned, male investors diver-
sify more than female investors, investors from the Porto
metropolitan area diversify more than the others, as do
investors located in habitats with up to 20 000 inhabitants,
together with CEOs and liberal professionals.
5.2.3. Robustness checks. It could be argued that our
diversification variable is a poor proxy for the level
of diversification investors achieve, for it does not
account for the fact that, for example, an individual
with only one fund is typically better diversified than
investors with only stocks.
To test this possibility, we use a different definition for
portfolio diversification, by attributing increasing weights
to mutual funds (regardless of the type of fund investors
hold in the portfolio).y Our results remain essentially
unchanged for weights 1 to 8. That is, our results change
dramatically when we use weight 9, and the literacy

yWe do not have information on the exact types of mutual funds investors hold, as there are no such questions in the inquiry.
According to Portuguese legislation, there are equity funds, bond funds, funds of funds, money market funds, real estate funds and
other funds. As at the end of December 2007, the number of participants in equity funds was 181 000, representing 10% of the total
number of participants in mutual funds (real estate funds not included) (CMVM 2008). This means that, in general, Portuguese
investors do not use equity funds for diversification purposes.
 Financial literacy and portfolio diversification
variables become insignificant (with the exception of the
sources of information). Estimates using weight 8 can be
seen in the first column of Table 5.y
On the other hand, one would expect that among the
set of investors with only directly held stocks, financial
literacy should predict a larger number of stocks in the
portfolio. Thus, we define a new variable, STOCKT,
which is equal to the number of different stocks in the
portfolio, and re-estimate our model using STOCKT as
the new dependent variable. The results are shown
in table 5 (second column), and are very similar to those
reported in table 4.z
Finally, one would expect that the probability of
holding a mutual fund (particularly an equity fund)
should increase with financial literacy. We estimate our
model using MUTUAL as the dependent variable, but the
results (table 5, third column) do not fully support this
prediction because the knowledge variable becomes non-
significant. The fact that we cannot discriminate between
investors with bond funds, real estate funds, money
market funds and equity funds could explain these results.
6. Conclusions
Investors’ financial information and financial literacy
have recently been emerging as particularly relevant
factors for explaining investor behavior. In this paper,
we sought to identify those factors that influence the level
of financial knowledge of individual Portuguese investors
and to investigate the relationship between financial
literacy and the behavior of agents by focusing on
portfolio diversification.
The results reported lead us to conclude that there is a
general problem of a low level of information amongst
individual Portuguese investors. In fact, two out of three
investors show that they have an insufficient level of speci-
fic knowledge about financial issues. We also conclude
that single men of around 43 years of age, with an inter-
mediate or higher educational level and who are liberal
professionals, are those with a higher level of information.
Our results show that the portfolios of Portuguese
investors are generally under-diversified: the average
number of assets in the portfolio is 2.6, and a significant
number of investors hold only one security. This finding is
consistent with the findings of other studies for European
countries (Eymann and Borsch-Supan 2002), and reveals
an even greater problem of under-diversification than the
US evidence shows (Barber and Odean 2000).
We provide evidence that financial literacy matters as
far as diversification behavior is concerned. It is possible
to infer that the level of specific financial knowledge,
the general educational level and the quality of the
information used by investors have an influence on the
number of different assets in the portfolio.
yThis weight means that, in terms of diversification, one mutual fund is equivalent to eight different stocks. One should note,
however, that holding a mutual fund is not necessarily equivalent to holding an equity fund.
zOLS estimates of Model (2), comparable to the second stage estimates in tables 4 and 5, are available from the authors upon
request.
525
Our estimates show that specific financial knowledge
is not only very relevant for stock market participation
but also contributes towards an increase in the number of
assets in the portfolio. Features relating to the educa-
tional level of investors are also revealed to be very
important for understanding the attitude towards diversi-
fication, even after controlling for a wide range of socio-
economic characteristics. Our results provide evidence
that the level of education contributes towards increasing
diversification.
Finally, the sources of information used by investors are
also significant in determining the composition of their
portfolios. As a matter of fact, many individual investors
seek help from their bank/account managers, trusting in
their advice. However, in terms of the number of different
assets that comprise their portfolios, these investors
behave similarly to those who do not seek any information
at all, which is in itself a surprising result. The high
importance of the relationships that retail investors have
with the market through their account managers means
that these professionals need to be suitably trained. This
allows them to provide investors with clear, simple and
accurate information, helping them to make a reasoned
and well-informed decision. In addition, information
ought to be given to investors when they most need it.
This usually happens when investors are confronted with
the need to take a decision, i.e. when the information is
relevant and immediately applicable.
Our results are of major importance from a regulatory
perspective. They justify and reinforce the efforts made
by regulatory authorities to increase disclosure of
financial information and to take action with the aim of
increasing investors’ financial literacy, thereby reinforcing
the efficiency of financial markets. Insufficient informa-
tion on the part of investors, for example, cannot be
disconnected from issues such as the importance of
unperformed credit liabilities or banking panic or the
emergence of fraudulent activities.
Acknowledgements
The views stated in this paper are those of the author and
are not necessarily those of the Portuguese Securities
Commission. We thank João Rebelo, James Conover
and two anonymous referees for helpful comments.
Any remaining errors are ours.
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Appendix

Table AI. Variable definition.

Variable Definition

PORTFDIV Proxy for diversification Number of different kinds of assets, plus the number of different types of securities, plus
the number of different issuers of each type in the portfolio. PORTFDIV varies
between 1 and 11, meaning that the most diversified portfolio has 11 different assets/
securities/issuers
STOCKT Proxy for diversification Number of different stocks in the portfolio
MUTUAL Binary variable, equal to 1 if the investor owns a mutual fund
PORTFDIVA Proxy for diversification Equal to PORTFDIV þ 8  MUTUAL
Financial literacy variables
INFOR Proxy for the financial knowledge of Created by the authors, varies between 0 and 5. Higher values mean a better
individual investors understanding of financial markets
INFORR Proxy for the financial knowledge of Created by the authors. Higher values mean a better understanding of financial markets
individual investors
INFOR_HIGH Proxy for the financial knowledge of Created by the authors. Binary variable, equal to 1 if the investor is in the top quartile of
individual investors the estimated level of literacy
Educational level. This variable has been ED_UNIV Dummy variable, equal to 1 if the maximum educational level is an intermediate or
considered under three categories university degree
ED_HIGH Dummy variable, equal to 1 if the maximum educational level is the 9th or the 12th
grade
ED_LESS THAN HIGH Dummy variable, equal to 1 if the maximum educational level is below the 9th grade
Sources of information. This variable has S_BANK Dummy variable, equal to 1 when the investor states having used advice from account/
been considered under seven categories bank manager to obtain information about the securities market
S_FRIENDS Dummy variable, equal to 1 when the investor states having used advice from friends/
family/colleagues to obtain information about the securities market
S_SPECIALIZED Dummy variable, equal to 1 when the investor states having used specialized
newspapers to obtain information about the securities market
S_PRESS Dummy variable, equal to 1 when the investor states having used other written press to
Financial literacy and portfolio diversification

obtain information about the securities market

S_TV/RADIO Dummy variable, equal to 1 when the investor states having used television/radio to
obtain information about the securities market
S_BULLETIN Dummy variable, equal to 1 when the investor states having used stock exchange
bulletin of quotations to obtain information about the securities market
S_NONE Dummy variable, equal to 1 when the investor states not having used any source to
obtain information about the securities market
Socio-economic variables
GENDER Binary variable, equal to 1 if the investor is a male
AGE Investor’s age, in years
MARRIED Binary variable, equal to 1 if married or living in a de facto union
FAMSIZE Number of persons in the household

(continued )
527
 Table AI. Continued. 528
Variable Definition

Net annual household income. Four cate- INCMISS Binary variable, equal to 1 if net annual household income is not known
gories have been considered INC_LOW Binary variable, equal to 1 if net annual household income below 24,938 E
INC_MEDIUM Binary variable, equal to 1 if equal to or above 24,938 E but below 37,410 E
INC_MED/HIGH Binary variable, equal to 1 if equal to or above 37,410 E but below 49,880 E
INC_HIGH Binary variable, equal to 1 if the net annual household income is above 49,880 E
Area of residence. Three geographical PORTO Binary variable, equal to 1 if the investor lives in the Porto metropolitan area
locations have been considered LISBON Binary variable, equal to 1 if living in the Lisbon metropolitan area
OTHER Binary variable, equal to 1 if living elsewhere
Occupation. Five categories have been CEO Binary variable, equal to 1, if the investor is the owner/boss
considered DIRECTOR Binary variable, equal to 1 if the investor is a senior or middle manager, or if the
investor’s profession is a technical, scientific or artistic one
INDEP Binary variable, equal to 1 if the investor is a liberal professional or an independent
worker
UNSKILLED Binary variable, equal to 1 if the investor is an office clerk, semi-skilled or unskilled
worker
INACTIVE Binary variable, equal to 1 if the investor is inactive (student or unemployed)
Habitat. Three types of habitat H_SMALL Binary variable, equal to 1 if the investor lives in a location of up to 4999 inhabitants
H_MEDIUM Binary variable, equal to 1 if the investor lives in a location of between 5000 and 19,999
inhabitants
H_BIG Binary variable, equal to 1 if the investor lives in a location of 20,000 or more
inhabitants
Social status. Based on a combination of ST_HIGH Binary variable, equal to 1 if the investor has a type A status (the highest)
education and occupation variables. ST_INTERMEDIATE Binary variable, equal to 1 if the investor has a type B or C status (intermediate)
Three categories have been considered ST_LOW Binary variable, equal to 1 if the investor has a type D or E status (the lowest)
Other control variables
M. Abreu and V. Mendes

MARKEVL Investor’s evaluation of access, liquidity Calculated as the simple arithmetical average of the scores attributed to these three
and the level of development of the characteristics. MARKEVL ranges from 1 to 7, higher values mean a better market
Portuguese securities market evaluation
MARKEVLMISS Binary variable, equal to 1 if the investor was unable to evaluate access, liquidity and
level of development of the Portuguese securities market
MARKRISK Investor’s evaluation of the market risk Varies from 1 to 7, higher values mean a better market risk evaluation
Trade experience. Four categories have TREX1 Dummy variable, equal to 1 if the investor has been investing for less than 1 year
been considered TREX2 Dummy variable, equal to 1 if the investor has been investing for between 1 and 2 years
TREX3 Dummy variable, equal to 1 if the investor has been investing for between 2 and 5 years
TREX4 Dummy variable, equal to 1 if the investor has been investing for over 5 years
Investment style. Four categories have been INV_VERY SHORT Binary variable, equal to 1 if it is a very-short-term investor: holds the assets for a
considered maximum period of 1 month
INV_SHORT Binary variable, equal to 1 if it is a short-term investor: holds the assets from one month
to one year
INV_MEDIUM Binary variable, equal to 1 if it is a medium-term investor: holds the assets from one to
three years
INV_LONG Binary variable, equal to 1 if it is a long-term investor: holds the assets for more than
3 years