The impact of financial literacy on household investment decisions in Colombo district, Sri Lanka: The mediating role of risk tolerance

Abstract

This study examines the impact of financial literacy on investment decisions among households in Colombo District, with particular focus on the mediating role of risk tolerance. Despite the growing financial complexity of Sri Lanka’s urban economy, household investment behaviour remains under-researched. Previous studies have primarily focused on individual investors, leaving a gap in understanding how collective household decisions are shaped by financial knowledge and behavioral traits. Addressing this gap and drawing on the Theory of Planned Behavior, the study explores the relationship between financial literacy, risk tolerance, and household investment decisions. A structured questionnaire was used to gather data from a sample of 395 families through stratified random sampling. The questionnaire covered financial literacy (knowledge, attitude, skills, and behavior), investment decisions, and risk tolerance. Data were analysed using SPSS version 27, while regression analyses tested direct effects and the mediating effect of risk tolerance was examined using Hayes’ PROCESS Macro model. The results revealed that financial literacy has a significant relationship with both investment decisions and risk tolerance. Risk tolerance was found to predict investment decisions and partially mediate the financial literacy-investment decision relationship. The findings of this study advance the literature of Sri Lanka through the exploration of household-level dynamics opposed to earlier studies which focused on individuals or market investors. The findings support that better financial literacy at the household level enhances risk-taking behaviour that obtains better long-term investment returns and improves resource allocations in the economy.