Behavioral biases have an enormous effect on investment plan decisions. By understanding our individual biases, we can minimize them and make more rational choices.
Experiential Bias is when an investor’s memory of an unpleasant past event creates the wrong assumption that something similar will reoccur; this can cause them to sell winning stocks while holding onto losing ones, leading them down an undesirable path of investing.
Negative Attribution Bias
Behavioral biases can have an enormously detrimental effect on investment decisions in multiple ways, leading to irrational choices that increase stress and anxiety levels; distorting objective market analysis by shifting credit for success backwards when losses occur; distorting objective market analyses using internal factors rather than external ones as causes; attributing success solely to internal forces while attributing losses solely external ones, etc. To combat them effectively use impartial research with multiple perspectives considered.
This questionnaire was adapted from previous studies conducted by Adil, Singh and Ansari (2021); Lusardi and Mitchell (2014) and included questions related to psychological biases (overconfidence bias, risk aversion, herding effects and disposition effects), financial literacy skills development and investment decision-making processes.
PLS-SEM modeling was used to assess hypotheses. Results demonstrated that overconfidence and disposition effects had significant influences on investment decisions through serial mediation; financial literacy did not act as a moderating factor. Further researchers can investigate this topic through longitudinal research while considering demographic characteristics as possible mediators between behavioral biases and investment decisions.
Self-Attribution Bias
This study employs a PLS-SEM model to explore the influence of cognitive biases on investment decisions using overconfidence, herding and anchoring as potential cognitive biases on investor decision-making. Furthermore, financial literacy may moderate this relationship.
Self-serving bias, or the tendency to attribute personal factors for success and external ones for failure, is an all too familiar behavioral phenomenon. It’s one reason people cling to losing investments with hopes they’ll recover later; but research shows this habitual behaviour may lead to overtrading and underdiversification that negatively impacts investment performance.
Self-serving bias is a potency force, one which can affect investment decisions at both an individual and national level. Carnegie Mellon and University of Zurich conducted a joint study which revealed that people often attribute success of climate-change initiatives in their country to internal factors while placing blame for failure on external elements.
Anchoring
Anchoring is a cognitive bias in which individuals give too much weight to the first piece of information they encounter, making it hard for them to adapt their views in response to new information, potentially leading to less-than-ideal decisions.
Example: If someone was amicable when first introduced to the team, but quickly became quiet after their first introduction, their amicability might get forgotten when making decisions based on first impressions alone. This same principle can apply when making investment plan decisions.
To reduce the influence of an anchor, it is crucial that individuals learn how to identify situations where they may be susceptible to being influenced. Critical thinking or red team methodologies may provide a means of seeking diverse viewpoints. Finally, using financial literacy as a moderator variable may reduce anchoring biases on decision-making (Shah, Ahmad & Mahmood 2021) since individuals with higher financial literacy levels tend to be less vulnerable to anchoring bias, herding bias, disposition bias or anchoring bias (Jain, Walia & Gupta 2019).
Overconfidence Bias
Overconfidence bias is a behavioral bias that often results in poor decision-making and risky behaviors that could end in financial losses or accidents. Overconfidence may be caused by social reinforcement and environmental influences as well as by individual’s past experience and self-evaluation, all factors which contribute to overconfidence being present in one’s life.
This research is the first of its kind to identify determinants of overconfidence bias among individual investors and analyze its influence on investment decisions. Semi-structured interviews were employed for data collection. SmartPLS then calculated reliability, item loadings, discriminant validity and convergence validity of its model to provide insights.
The results reveal that determinants of overconfidence bias have a substantial influence on investment decisions, as well as how overconfidence and disposition effects mediate between behavioral biases and investment decisions. Furthermore, this model offers significant insights for financial intermediaries and policymakers who wish to identify and mitigate any determinants of overconfidence bias that hinder investors from making sound investment decisions.
