Financial Literacy, Retirement Planning, and Household Wealth

There is ample empirical evidence documenting widespread financial illiteracy and limited pension knowledge. At the same time, the net worth distribution is heavily dispersed and many workers arrive on the verge of retirement with little or no personal wealth. This paper is the first to investigate the relation between financial sophistication and household net worth relying on specific measures of financial knowledge and skills rather than crude proxies. For this purpose, we have designed a new module for the Dutch DNB Household Survey. Our findings provide evidence of a statistically and economically significant positive effect of financial sophistication on net worth. Moreover, we highlight and document empirical evidence of two channels by which financial sophistication facilitates wealth accumulation. First, financial skills increase the likelihood to invest in the stock market thereby opening the possibility to benefit form the equity premium and improving the opportunities for risk diversification. Second, financial sophistication boosts retirement planning behavior by households, thereby providing an important channel for the development of savings plans and creating instruments for self-control. In addition, our results suggest that respondents who are relatively confident on their own financial skills have a higher propensity to plan. To take into account that wealth, portfolio management and planning activities might exert an independent effect on financial literacy, we employ instrumental variable regression techniques using information on economics education.