Determinants Of Household Portfolio Composition

Abstract

Personal Finance is concerned with how people spend, save, and invest their financial resources to achieve financial objectives. This is an important issue now in the minds of the occupants of an Indian household. The household has several options to park their savings. They include simple risk-free post office savings scheme such as post office monthly income scheme, recurring deposits, term deposits, national savings certificate etc. A certain of these schemes are also available in banks, both private and public sector. The money parked in banks is safe up to certain limits provided the banks have insured it with Deposit Insurance and Credit Guarantee Corporation (DICGC). Then follows the products from insurance companies, which offer pure insurance products as well as investment products. Mutual fund companies offer different kind of products like debt oriented, equity oriented, monthly income schemes, sector schemes etc. One can also invest directly in the shares of any company. Thus, there are several investment options available to the households. Each and every financial asset has its own characteristics in terms of safety, liquidity, and rate of return. Thus, one has to look in to one’s objectives and try to match it with the avenues in which to park one’s money. However such decisions call for the awareness about the various options and the knowledge about the risk characteristics of those options.

The savings pattern in India show that the households prefer to save money more in physical assets than in financial assets. Within the financial assets, they prefer fixed interest-bearing instruments such as bank deposits, small savings, PF/Pension Funds, and life insurance funds. The report named Project OASIS Report (2000), an Expert Committee for devising a Pension System for India, was constituted by the Ministry of Social Justice and Empowerment, Government of India. It has recommended for the implementation of defined contribution pension plan for the work force in India. Kelkar committee (Task force on direct and indirect taxes 2002) was constituted by the Ministry of Finance, Government of India to rationalize and simplify procedures, on direct and indirect taxes. It has recommended the removal of tax rebates to the salaried employees and the deduction under sections 80L, 80CCC. It also recommends the introduction of Exempt Exempt Tax (EET) policy. Under EET, the contribution to the specified savings is exempt from tax. The income earned by these savings is also exempted from tax. However, the withdrawal(s) when made will be taxed in that year. Rakesh Mohan committee constituted by Department of Economic Affairs (Budget Division), the Ministry of Finance, Government of India (2004) to advice on the administered interests and rationalization of existing savings instruments, has recommended the consideration of the weighted average of G-sec yields for the previous two years to work out the benchmark for administered interest rates for saving instruments offered by the GOI through post offices.

The Government of India, on the suggestion of Project OASIS Report (2000) introduced the defined contribution pension plan to the newly recruited employees of the Government of India, except the Armed Forces from 1st January 2004. 7 State Governments have also notified the introduction of this scheme in line with the Government of India for their newly recruited employees. During the financial year 2005-2006, the income tax rebate for the salaried class was replaced with a new section (Section 80C), which provides for total deduction to the amount invested in a broad menu of financial assets (up to a maximum of Rs 1,00,000) in arriving at the individual’s tax liability/payment. The Finance Ministry, Government of India has set up a committee under R. Kannan (2005) to provide the road map for the implementation of the Exempt Exempt Tax policy. Thus, on the one hand the household prefers to save money in safe investment avenues. On the other hand the government tries to reduce its fiscal deficit by transferring the risk in pension payment to the employees by making them responsible for managing their retirement through defined contribution scheme. This new pension system calls for the individual to take the asset management decision, such as selecting a fund manager from a group of competing fund managers, selecting a scheme out of the proposed three schemes according to one’s risk tolerance etc, which calls for financial literacy among the households. A strand of literature on personal finance issues has looked at the relationship between financial knowledge and other demographic and contextual variables on the savings behaviour of households. These empirical studies related to savings behaviour of households have shed light on the determinants of the household behaviour. For Example, Axel Borch-Supan and Angelika Eymann (1999) in Germany, Luigo Guiso et al (1999) in Italy and James Bank and Sara Smith (2000) in UK analysed the household portfolio composition and found that, in general, the household portfolio is simple and less diversified. L.C. Gupta (1991, 1993, 2005), L.C. Gupta, C. P. Gupta and Naveen Jain (2001) found majority of the Indian households’ risky assets portfolio contains 3-10 companies’ shares. Axel Borch-Supan et al (1999), Rob Alessie et al (1999) in Netherlands found the positive impact of age on the ownership of risky assets. Luigio Guiso and Tullio Jappelli (1999) in Italy found the positive relationship between age and ownership of risky assets. They also found similar relationship between the age and the share of risky assets invested in total assets. Carl Bertuat et al (2000) in the USA found the positive relationship between income and ownership of risky assets, while Defined Benefit Pension is negatively related with it. Stefan Hocheguertal et al (1997) in Netherlands found income to be positively related with the share of risky assets investment of the total wealth. James Poterba et al (1999) in the USA found education and marginal tax rate positively related with the ownership of risky assets. James Poterba et al (1999) and Stefan Hocheguertal et al (1997) found education and marginal tax rate positively related with the share of risky assets investment in the total wealth. Rob Alessie et al (1999) in the Netherlands found household size to be negatively related with the ownership of risky assets, while Yilmazer (2000) in the USA found similar relationship between household size and share of risky assets investment in the total wealth. Jonas Agell et al (1990) found Swedish white-collar workers to be positively related with the ownership and share of risky assets in the total wealth. Zvi Bodie and Dwight B. Crane (1997) found home ownership to be positively related with the ownership of risky assets. Of late few studies in the USA have analysed the impact of financial knowledge (Marianne A. Hilgert et al 2003), and planning (Lusardi 2001) on household portfolio composition and found that they have a positive impact on household portfolio composition. Few studies (B. Douglas Bernheim et al 1996; Patrick Bayer et al 1996) in the USA also found the positive impact of employer related retirement education on retirement wealth, retirement savings and the higher rate of participation and contribution in 401(k) plans. However, in India very few studies have analysed the capital market investors’ behaviour. Hence this study makes an attempt to scrutinize the relationship between financial knowledge, planning and household portfolio composition. Thus, the factors included in this study to determine its impact on household portfolio are financial knowledge, planning, age, income, education, occupation, marginal tax rate, household size, home ownership and pension benefit status. It is hoped that such a study would help in understanding the savings behaviour of Indian households better. In particular, it is of interest to find which demographic variables explain the choice of investment in risky assets. Similarly, it is of interest to find at the extent to which financial awareness and knowledge act as facilitator in making the choice of risky investments.

The study was carried out in Coimbatore and Ahmedabad. For the study a questionnaire containing 40 questions was prepared. The sample size in Coimbatore and Ahmedabad were 345 and 227 respectively. The study was carried out from 15th October 2004 to 15th January 2005 in Coimbatore and from 20th Feb 2005 to 20th April 2005 in Ahmedabad. The study used probit and tobit models to find out the factors, which influence the ownership of risky assets and the proportion of total wealth, invested in risky assets. These two dependent variables reflect the inclination and comfort of the households in making investments in risky assets. Model calibration is used as a criterion to assess the goodness of fit of the model. Model calibration evaluates how well the observed and predicted probabilities agree over the entire range of probability values. Hosmer and Lemeshow test is a commonly used test for the goodness of fit of the observed and predicted number of events. This test is carried out to test the goodness of fit of the model and found the fitness of the model. In Coimbatore, the finding of the study is that the financial knowledge, marginal tax rate, age, income, and pension benefits have an impact on the ownership and proportion of investment in risky assets. Planning and household size impacts only the proportion of investment in risky assets. Financial services personnel differed from other occupational category respondents both in the ownership of risky assets and in the proportion of investment in risky assets.

In Ahmedabad, the study finds that the variables: financial knowledge and pension benefits status are the determinants of the ownership and proportion of risky assets investments. Variables such as age, income, marginal tax rate, and occupation have an impact only on the proportion of risky assets investments in the total wealth. In Combined Sample, the study finds that financial knowledge, pension benefit status, age, income and marginal tax rate are the determinants of the ownership and the proportion of risky assets investments. Planning and education impacts only the proportion of investments in risky assets. The ownership of risky assets and the proportion of risky assets owned by the academicians and managers are less when compared to the financial services personnel. In case of unclassified category of respondents the proportion of risky assets owned by them is less when compared to financial services personnel. Thus, the study finds that the variables used in the study are, significant in Coimbatore or Ahmedabad or Combined Sample in explaining the proportion of risky assets investment in the total wealth. However, only two variables: Financial Knowledge and Pension Benefit Status are significant in explaining the ownership of risky assets and the proportion of risky assets investment in the total wealth among the households. Thus, one can conclude that the lack of financial knowledge acts as an entry barrier for the households in owning the risky assets in their portfolio.