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Impact of Financial Literacy and Behavioural Biases on Investment Decision-

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DOI: 10.1177/23197145211035481

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Suresh G.1

Abstract
Investors’ financial literacy entails making sound investment decisions and the behavioural biases or irrational behaviour in decision-
making that are collectively formed by heuristic bias, framing effect, cognitive illusions and herd mentality factors. The present study
examines the combined impact of financial literacy and behavioural biases on investment decisions. A questionnaire was developed
using Likert scaling technique to elicit study variables and collected data was analysed using SEM technique. The results showed that
heuristic bias had a significant positive association with the creation of behavioural bias in decision-making. However, the framing
effect, cognitive illusions and herd mentality have negative associations in the formation of behavioural biases. Further, investors often
practice and follow heuristic biases rather than other irrational techniques for making investment decisions. Therefore, the financial
literacy of individual investors has a significant impact on affecting stock market investment decisions.

Keywords
Financial literacy, behavioural bias, investment decisions, framing effect, cognitive illusions, heuristics, herd mentality

Introduction to predict market movements, which pushes them to make

In the investment world, investors often make rational or
irrational decisions based on their understanding and it was
widely discussed in traditional finance and behavioural
finance. Traditional finance asserts that investors are
rational and formulate wise investment decisions. Investors
try to maximize profit or gain by selecting the best
investment alternative even in uncertain times (Kumar &
Goyal, 2015). According to efficient market hypothesis,
the stock market is always perfect and efficient and the
stock prices reflect all prevailing information (Fama,
1970). Behavioural finance contradicts such a reality of
rational investment decisions among investors. Behavioural
finance however, focuses on the behavioural facets of
irrational decision-making among individual investors
(Semenov, 2009). Behavioural biases are believed to have
a direct impact on investment decisions, which ultimately
leads to less investment gains in the stock market.
Behavioural finance is an area that captures the irrationality
of investors and the biases to which investors are prone.
These cognitive biases are due to the inability of investors
biased investment decisions (Stanovich & West, 2008).
Behavioural finance is a relatively new school of thought
that controls the management of psychology about investor
behaviour and its influence on decision-making. Behavioural
finance has gained massive impetus recently in stock
markets investments.
Behavioural finance is a sub-field of behavioural
economics, linking psychological, cognitive and behavioural
premises with traditional economics and finance, to
describe why investors make irrational decisions. Unlike
traditional finance, the behavioural approach assumes that
there are restrictions to arbitrage leverage and that not
all investors are rational. Superfluous information and
emotional issues play a key role among individual investors
in investment decision-making (Banerjee, 2011). The basic
postulation of traditional theory is that investors are rational
and continually seek to capitalize on their own benefit by
improving wealth (Shapira & Venezia, 2001). In fact, more
often, the investor considers the thumb rule rather than
long and laborious mental calculations that can lead to
suboptimal options and can create friction in the market.

1 Department of Commerce, CHRIST (Deemed to be University), Bangalore, Karnataka, India.

Corresponding author:
Suresh G., Department of Commerce, CHRIST (Deemed to be University), Bangalore, Karnataka 560029, India.
E-mail: suresh.g@christuniversity.in
2
However, investors are not rational always and are not able
to equip infinite computing capacity to believe in all potential
circumstances to make sound investment decisions.
Traditional theory assumes that irrational investors are
eliminated from the market by arbitrage and it can also be
challenged in many aspects (Hirshleifer & Teoh, 2003).
Decision-making is a psychological and cognitive
process that results in the selection of investments.
The approach to behavioural finance divulges the reality
that individual investors are not often highlighted and
does not take into account fundamental and technical
investigations in investment decisions. It focuses on how
individual investors gather and recognize information to
make evidence-based decisions and discover the influence
of emotional aspects on investment decisions (Waweru
et al., 2008). Believers of the behavioural theory argue that
investors fundamentally behave in a ridiculous way on
investment decision-making. The phenomenon certifies
that investors often buy stocks when prices go up and sell
them when prices go down. Recently, academicians and
experts have tried to find how the emotions and biases
drive overall behaviour of an individual investor. They
highlighted the main role of heuristics, cognitive illusions,
framing effect and herd mentality as a guide to make such
irrational investment decisions (Economou et al., 2010).
Put together, financial literacy of individual investors has
had a strong impact on investment decisions.
The aim of the study is to examine how financial literacy
correlates with behavioural biases in investment decisions.
Financial literacy guides individual investors to avoid
irrational decisions to some extent. In earlier days, investors
did not have enough education to search for the fundamentals
of the broad dimensions of the company, industry and
economy. Ideally, they would adopt technical dimensions
and irrational behaviour in investment decision-making.
However, investors now have sufficient education with
extensive financial literacy and often use these phenomena
in investment decisions. Therefore, the impact of financial
literacy and behavioural biases is the true motivation to
initiate such seminal research in an empirical manner. This
study contributes to quantify the investment decision-
making tendency of individual investors in India, to what
extent they place financial literacy in decision-making and
how they influenced with behavioural biases can estimate.
It also helps determine if individual investors take a rational
or irrational approach to investment decisions due to
financial illiteracy.
Background of the Study
Individual investors are partially rational and partially
irrational in making investment decisions. They have
mental biases and cognitive restrictions, which prevent
them from making rational decisions. Various behavioural
biases often forbid individual investors from taking rational
FIIB Business Review
decisions (Zamri et al., 2017). Behavioural biases are
categorized into heuristics, framing effect, cognitive
illusions and herd mentality, and have effect on investment
performance of individual investors’ portfolio. They are
either inherent in investor psychology or in view of
emotional decisions existing in general understanding of
investment market. As per heuristic phenomenon, anchoring
bias, representativeness and overconfidence have been
involved in transforming individual investors as to stock
market investments. Framing effect includes regret aversion,
mental accounting and endowment effect (Lin, 2011).
Cognitive illusions are explained by conservatism,
confirmation and hindsight bias (Lad & Tailor, 2017). Herd
mentality which is associated with information processing,
social group and bandwagon effect has influence on stock
market decisions (Bekiros et al., 2017). Further, financial
literacy dimensions in terms of financial competency,
financial proficiency and financial opportunity streamline
their decisions in stock market. The study will support the
finding of the various kinds of behavioural biases and its
influence on investment decision-making.
Financial Literacy
Investors’ financial literacy is all about their awareness and
understanding of investment ideas and information, thus
ensuring the capability to make informed, safe and effective
decisions on investments. In a broad sense, it is designated,
as understanding the economy and how economic situations
and events influence decisions (Worthington, 2006). In a
narrow sense, it is defined as basic money management
instrument used for savings, budgeting, investment and
insurance (Gallery et al., 2010). Financial literacy is the
capability to recognize, evaluate, manage and communicate
on stock market investments (Vitt & Anderson, 2001).
Financial literacy can be discussed in three ways such as
financial competency, financial proficiency and financial
opportunity. Financial competency is concerned with
equipping relevant knowledge on different financial
products (Shobha & Shalini, 2015). Financial proficiency
deals with the capability to apply knowledge and correspond;
creating financial literacy for effective decisions (Hilgert
et al., 2003). Financial opportunity highlights that a
financially knowledgeable investor should have the
opportunity to invest funds and enjoy gain on investments.
Behavioural Biases
Investment decisions in daily life rely on the mix of various
factors such as tendency, motive, passion and social
interaction. Investors make investments according to
available funds, periodical and financial objectives
(Muhammad & Abdullah, 2009). Investors perform
behavioural biases because of lack of technical proficiency
and belief in their skills for effective decision-making.
Suresh G. 3
Behavioural biases, such as herd mentality, heuristics,
cognitive illusions and the framing effect influence rational
decision-making. Individual investors have less opportunity
to evaluate stock due to lack of knowledge and interest,
high cost and limited time. Therefore, they exercise simple
heuristics or rule of thumb to make decisions (Lo,
2005). Framing effect describes the state of an individual
investor’s mind in decision-making. Cognitive illusions
are systematic patterns of deviation from a specific norm
or rationality in evaluations. Cognitive illusions induce the
investors to follow certain norms in selection of investments
(Agarwal et al., 2016). Herd mentality is the tendency of
investors to abandon self-belief and information but follow
others’ action in decision-making. Herd mentality has
tremendous effects like high volatility, bubbles and market
imperfections (Braha, 2012). The combination of heuristic
bias, framing effect, cognitive illusions and herd mentality
cause irrationality and it is referred to as behavioural biases
in investment decisions. Behavioural biases could establish
a way to deviate from intrinsic worth and cause inefficiency
in market (Babajide & Adetiloye, 2012).
Investment Decisions
Investors make decisions based on experience and
knowledge on the stock market. Behavioural finance
focuses on how individual investors act and interpret
information to make investment decisions. Behavioural
finance is getting a main element of decision-making, since
it affects behaviour of investor significantly (Kannan &
Vijayakumar, 2015). Investment decisions of investors
project their intention to select better stocks. Intention
is reflected in estimation of gain that is determined by
using financial literacy level and biases in investments.
Behavioural finance assists investors to make exclusive
decisions and avoid mistakes in investments. Investment
decisions are often surrounded by complexity and
uncertainty; it can assist financial literacy and cognitive
estimations to select suitable stocks (Kafayat, 2014). This
standpoint makes investors’ prioritize their intuition over
rationality assumed by modern finance approach.
Behavioural finance is a peculiar science that combines
financial sense and cognitive psychology in investment
decisions. In this way, financial literacy on investment
and behavioural strategy could be the antecedents in
determining investment decisions of an investor (Sukanya
& Thimmarayappa, 2015).
Literature Review
The literature on financial literacy, behavioural biases, and
their effect on investment decision have been discussed in
several previous studies in many ways. The construct
financial literacy consists of competency, proficiency and
opportunity as to stock selection. Behavioural biases are
composed and explained by heuristic biases, framing
effect, cognitive illusions and herd mentality components.
Detailed discussions have been held from this point of
view.
Behavioural Biases
Heuristic Bias
Heuristic bias is basically called as rule of thumb; it
simplifies the decision-making process of investors,
especially in uncertain and difficult circumstances by
reducing the intricacy of assessing possibilities and
forecasting benefits to make easy judgments (Kahneman &
Tversky, 1974). Heuristic bias possibly impedes positive
gain in investment which could simultaneously imitate
in reduced portfolio gains. The heuristics bias affect
the private investors’ portfolio construction and even
professional investors influenced by the heuristic bias
(Gavrilakis & Floros, 2021). Further the heuristics bias
strongly influencing the investment decision making of
investors with the mediating factor of risk tolerance
(Salman et al., 2020). Hence based on the risk tolerance
level of investors, heuristic bias plays significant role.
Heuristic bias can be explained in three ways such as
anchoring bias, representativeness and overconfidence.
Anchoring bias is an emotional state of affairs that exists
when investors give unwanted importance to statistically
random and emotionally determined anchors which direct
them to make decisions that are not basically rational
(Tseng & Yang, 2011; Zahera & Bansal, 2018). Anchoring
bias can also be described as the investor’s tendency to
anchor their considerations to a rationally irrelevant
point in investment decision-making (Pompian, 2006).
Anchoring bias is concerned with riskless trading behaviour
among the investors (Ofir & Wiener, 2012).
Representativeness is a dedicated tendency to relate a
new event with an intention of knowing the event and
through which only investors make investment (Anderson
et al., 2005). Decisions are made by comparing the present
event with previous events and making investments
accordingly. It can create some bias in terms of investors
placing more importance on recent incidents and undervalue
the long-term gain in investments (Kubilay & Bayrakdaroglu,
2016; Zahera & Bansal, 2018). Overconfidence is essentially
the over estimation on one’s own ability because investors
believe that they can make better decisions than others can
but in reality it is not achievable (Larrick et al., 2007).
Further, in a study, Ahmad and Shah (2020) found that
overconfidence can impair the quality of investment
decisions of investors. There are two major implications of
overconfidence with regard to investor perspective. The
first is failure to generalize the information and the next is
to do extra trading because of such failure (Shefrin &
Statman, 2000). Overconfidence induces to trade more
quantity and take high risks; it leads to market inefficiency
due to more volatility and mispricing (Shah et al., 2012).
4
Based on the above propositions, it is hypothesized in the
following way.
H1: Anchoring bias, representativeness and overconfi-
dence collectively form the heuristic bias in invest-
ment decision-making.
H2: Heuristic bias has significant positive influence
with behavioural biases.
Framing Effect
Framing effect is often called as prospect theory.
It describes how investors manage uncertainty and risk in
investments. According to framing effect, investment
decisions can be segregated into two phases that is framing
phase and evaluation phase (Dhar & Zhu, 2006).
Furthermore, it is believed to be irregular and contradictory
in decision-making. Framing effect emphasizes that
investors formulate decisions based on possible value of
loss and return rather than final results and consequently
make decisions on perceived gains than perceived loss
(Kahneman & Tversky, 1979). Further a study found that
the framing effect has a very strong effect on investors’
decision-making (Tabesh et al., 2019). In keeping with
Thaler (1990), mental accounting is composed of three
components. The first component deals with how outcomes
are received and experienced; the second discusses the
fund inflow and outflow from an account; and the third
evaluates the regularity of account. Investors normally
assess the inflow and outflow, and the reaction will be
uncertain to organize investments with regular returns.
However, components of mental accounting decrease the
financial standard of substitutability (Carlin, 2009). Excess
return will stimulate investors because of the assessment
between part information, to continue until enhanced
returns are realized. Further a recent study states that the
understanding of mental accounting significantly improve
the decision-making quality and in turn increase the
profitability (Mahapatra & Mishra, 2020). Furthermore, in
general investors use to assess the trade-off between the
cost and return of investment and the mental accounting is
influencing in the process of assessing the trade-off.
Hence, ultimately the mental accounting is influencing
the investment decision-making of investors (Zhang &
Sussman, 2018).
Endowment effect reveals that investors desire more in
selling than purchasing. It has strong implications and
claims that investors treat different costs differently
(Shefrin & Statman, 1985). The cost of selling stock from
a portfolio of an investor is considered as a loss and
opportunity cost is considered as a prior gain. The former
should carry more weight as investors refuse to accept
change when they hold a stock. A study stating that a
significant impact of endowment effect on the investors
risk behaviour and therefore endowment effect have effect
on investment decision-making process of investors
(Holden & Tilahun, 2021). Regret aversion is experienced
FIIB Business Review
by the investors who commit mistakes in the process of
judgement. Investors regret certain processes in investment
decisions because of failure of bringing expected return
and this is termed as regret aversion (Talha et al., 2015).
However, avoiding regret is an emotional state. Regret is
expressed when an investor observes that their decision is
wrong, even if it was initially believed correct. Regret
is linked with the logic of accountability for choice,
and therefore differs from the aggravation of assigning
responsibility to external components for poor results
(Michenaud & Solnik, 2008). Further the regret averse
investors are more sensitive hence they use to invest in
stocks which have lesser risk than investing in the stocks
which have less return (Awais & Estes, 2019). It helps to
determine the following hypotheses.
H3: Mental accounting, endowment effect and regret
aversion collectively form framing effect in
investment decision-making.
H4: Framing effect has significant positive influence
with behavioural biases.
Cognitive Illusions
Cognitive illusions are associated with investors’ acceptance,
understanding and assessment in making investment
decisions (Lei & Seasholes, 2005). Cognitive illusions can
affect the investors’ decision-making process and it
facilitates to avoid making mistakes in financial decisions.
Therefore, knowing and recognizing cognitive illusions
helps to improve the allocation of investments. There is a
self-belief in the capability to make the right decisions
based on available information, but in fact the right
decisions are not able to be made (Kim & Nofsinger, 2008).
A recent study stating that the investors’ investment
decisions not fully rational and it to be prone towards bias
like cognitive illusions (Singh et al., 2016). Conservatism
is a mental process where individual investors depend on
their earlier viewpoint to forecast information to acquire
new ideas. Here, investors depend mainly on experience
than on learning new techniques in making investments.
Preferences based on past experiences were not consistent
enough; investors with rigorous conservatism bias will be
determined by their preferences. Conservatism shows that
investors failed to integrate new information by continuing
to clutch their past prediction (Alwathainani, 2012) and a
recent study also state that the conservatism bias has
negative impact on the investment decision-making if
investors’ financial literacy is lesser (Ahmed at al., 2020).
Further a study found that overconfidence, conservatism
and availability bias have an impact on the investment
decisions of investors (Bakar & Yi, 2016).
Investment decisions rely on availability and information
gathering of stocks and its features along with anticipation
of what others will perform so as to make correct valuation
of stocks in the future. Confirmation bias leads to a tendency
for investors to focus on information that corresponds to
Suresh G. 5
their opinions, avoiding them from reacting to any other
information. Confirmation bias can lead to the formation of
bubbles in the financial markets (Pouget et al., 2017).
Hindsight refers to an investor’s tendency to find past
events more predictable than previous results (Biais &
Weber, 2009). It makes a person convinced that the
circumstances of an event after it has occurred were
expected and based on historical data. There is a faith in
predictability, as it is considered as a capability to make
investment decisions (De Miguel Guzman et al., 2018).
The reason why forecasting is easy, is concerned with the
reality that investors are biased by their knowledge of what
occurred. In this way, the following hypotheses are proposed.
H5: 
Conservatism, confirmation and hindsight bias
collectively form cognitive illusions in investment
decision-making.
H6: 
Cognitive illusions have significant positive
influence with behavioural biases.
Herd Mentality
Herd mentality refers to the state of affairs where rational
investors commence to perform irrationally to replicate the
evaluations of other investors in investment decisions
(Malik & Elahi, 2014). Herd mentality is the investor’s
tendency to go after the crowd, because the decisions made
by most investors are considered as right forever. A herding
investor will make decisions as per the actions of a crowd
in buying and selling of stocks. Herd mentality has been
found in both upward and downward phases in market.
Moreover, high volatility and volume are the outcome of
herding effect. Decision-making process relies on first-
hand information collected from reference groups rather
than own estimation (Mahapartra & Mehta, 2015).
Investors pay effort on information processing from the
crowd so as to make investment decisions. Often investors
ignore their own information regardless of its accuracy in
decision-making and blindly follow the herd, even if the
crowd may be wrong. Their information processing always
follows the herd and then gets delight based on whole herd
mistake rather than personal mistake.
Trading and investment psychology of an investor is
affected by the bandwagon effect. Bandwagon effect is a
situation in which investors feel safer and assured if they
come to know that their decision is consistent with the
decision of others (Coval & Tyler, 2005). The bandwagon
effect, however, can often be the fundamental rationale.
Investors fear being excluded from the stock when they
observe it increase; rather than looking at the basics of the
stock, they begin buying stocks since they think everybody
else is undertaking the same (Pertiwi et al., 2019). Investors
have personal attachment with certain groups. They
often make decisions based on the movement of social
groups. Social environment has determined the investor’s
behaviour in investment decisions. If an investor is polluted
with infectious thoughts once, their behaviour becomes
irrational and they make decisions accordingly. Social
groups have sizable control in the stock market volatility
(Mittal, 2010). It has been checked with the following
hypotheses.
H7: Information processing, bandwagon effect and
social groups collectively form herd mentality in
investment decision-making.
H8: Herd mentality has significant positive influence
with behavioural biases.
H9: Behavioural biases have significant positive influence
on investment decisions of individual investor.
Financial Literacy
Financial literacy is the capability to recognize how money
acts around the globe, how investors can earn money and
skill to administer and get more returns from investment
(Giesler & Veresiu, 2014). Financial literacy can be
measured by means of financial attitude, knowledge and
behaviour on different investment outlets and financial
dimensions. Financial literacy enables the investor to
navigate with informed investment decisions and reduces
the possibility of being misled (Agarwal et al., 2015).
An investor with enough financial literacy has familiarity
on arithmetic, budgeting, money management and capability
to predict expenses and incomes. Furthermore, financial
competency on savings, expenditure, borrowings and
investment is of supreme importance for every investor
making investments in stock market. Competencies lead to
select suitable stock for both speculative and long-term
investments (Ganapathi, 2014). Adding on in a study
Ahmed et al. (2020) found that the financial literacy has
positive impact on the investors investment decision.
Financial proficiency is related to the quantum of
investors’ financial knowledge. Financially strong investors
can plan in advance, discover and utilize information.
Moreover, it helps the investors to be get familiar with
when to get advice and how to proceed on such advice.
It helps them to make superior gains (Hastings et al., 2013).
Financial opportunity is the chance to make investments.
Financial inclusion, compulsory dematerialization of
stocks and maintaining bank account permits an individual
to take part in the capital market arena. Such financial
opportunity motivates individual investors to take part in
stock market investments. Therefore, application of financial
knowledge and performance in financial market is mostly
relied on financial opportunity (Pareek & Dixit, 2016).
The following hypotheses has been proposed in this way.
H10: Financial competency, financial proficiency and
financial opportunity collectively form financial
literacy in investment decision-making.
H11: Financial literacy has significant positive influence
on investment decisions of individual investors.
6 FIIB Business Review

Research Objectives and Problem
The study sought to establish the impact of behavioural
biases and financial literacy on investment decisions of
individual investors. The study assists to recognize the
various types of behavioural biases and their potential
impact on investment decisions. Similarly, how financial
literacy transforms their investment decisions is also
examined. Investment decision-making differs from one
investor to another due to the development of own tenets or
the imitation of others. It develops irrational behaviour in
investment decisions. Then how can financial literacy
trade-off be measured in such a phenomenon?
hence one hundred and forty cases is enough, but for better
result researcher intended to collect data from 250
individual investors. Initially researcher collected data
from 267 respondent, later while screening the data it is
found that 17 responses are had some missing or
inappropriate responses. Hence that 17 responses were
ignored for further analysis.
To concurrently assess and examine how the process of
investors’ decision is associated with financial literacy and
behavioural biases, the structural equation modelling
(SEM) has been used after measuring the data quality using
confirmatory factor analysis.

Results and Discussion

Methodology
Socio-economic Background
To examine the combined impact of financial literacy and
behavioural bias on investment behaviour, the required The questionnaire asked respondents to provide their
data was collected from individual investors through socio-economic details like age, gender, education, income,
questionnaire in the google form. The questionnaire experience and occupation. Table 1 describes the socio-
consisted of 22 self-assessment questions, of which 12 economic background of individual investors
questions were related to behavioural bias; three questions With respect to gender, about 84% are male and only
to elicit financial literacy and seven questions were related 16% are female investors. Age reveals that 21% are in less
to the socio-demographic conditions of the respondents. than 30 years of age group, 44% are in the 30–50 year age
The questionnaire was divided into three parts—the first group, and 35% are more than 50 years of age. Educational
part covers socio-economic and demographic variables of qualification confirms that 33% have completed their
gender, age, educational qualification, occupation, income school education, 42% have completed UG or diploma and
and experience in investment, followed by the second part 25% have completed their PG or professional education.
dealing with behavioural bias and financial literacy and Monthly income shows that 46% are in the income group
last part of the questionnaire was asking suggestions related of less than `50,000 per month, 36% are in `50,000–
to the subject. 100,000 income per month and 18% are in the more than
The data was collected from 250 individual investors by `100,000 income per month; 34% of investors have less
adopting convenient sample method. The individual than 2 years of experience, 43% of them have 3–10 years
investors’ list were collected from various investment of experience and 23% of them have more than 10 years of
consultants, portfolio advisors and stock trading terminals
in southern states of India. The main criteria assigned for
sample selection was that an investor should have two Table 1.  Socio-economic Background
years of trading experience and has to reside in any of
Socio-economic
southern states—Andhra Pradesh, Telangana, Karnataka,
S. No Background Variables Frequency
Kerala and Tamil Nadu. The questionnaire survey was
conducted to increase efficiency in data precision and 1. Gender Male 84%
Female 16%
decrease interviewer bias because respondents can take
2. Age Less than 30 years 21%
their liberty while answering the questionnaire. Moreover, 30–50 years 44%
the content and face validity of the survey was pre-tested More than 50 years 35%
with 50 investors in the study area prior to the actual 3. Educational School education 33%
survey. The use of words, meaning and measurement qualification UG/Diploma 42%
items was discussed with financial experts, academic PG/Professional 25%
professionals and investment advisors in the financial 4. Monthly Less than `50,000 46%
market. Accordingly, clarification in questions and relevant income `50,000–1,00,000 36%
More than `1,00,000 18%
instructions guided individual investors to effectively
5. Experience in Less than 2 years 34%
answer the questionnaire. investments 3–10 years 43%
The sample size was determined by adopting Jackson’s More than 10 years 23%
(2003) suggestion to determine the sample size based on 6. Occupation Business/Profession 52%
the parameters to estimate. As per Jackson’s (2003) Employed 31%
suggestion, for each parameters at least 20 cases are Agriculture/Others 17%
required. In this study author estimating seven parameters Source: Survey data.
Suresh G. 7

experience in investments. Occupation discloses that 52% after which the convergent validity is measured. Reliability
are engaged in business or profession, 31% employed in is documented as the internal consistency of every factor
private or government sectors and 17% are agriculturists, that is employed to assess a latent construct.
retired, homemakers, and so on. Table 2 depicts that for all the factors, correlation
amongst the factors are in the range of 0.781 to 0.919, and
in Table 3 Cronbach’s alpha value has been ascertained and
Impact of Financial Literacy and
its values were found in the range of 0.83 to 0.92, which is
Behavioural Biases in Decision-making
greater than the lowest threshold value of 0.70. These
Investment decision-making is the process that blends results proving that multi-collinearity is not the main issue
logical and psychological calculations of investors. However, among the variables.
investment decisions are rational according to traditional
Measurement Model
finance theories. Contrary to that, modern finance theories
advocate that investment decision-making are not governed SEM determines the impact of exogenous construct on
by rational deliberations. Investment decisions taken by the investment decisions, as it institutes a path for the
investors are also frequently spontaneous. Contrarily, instantaneous examination of the entire model that seeks
decision-making is subject to four major behavioural biases various hypothetical relationships. At this point, a two-step
in the form of heuristic bias, framing effect, cognitive analysis is performed where a measurement model with
illusions and herd mentality. However, financial literacy and latent construct is first analysed, and then a structural
behavioural biases aspect have strong influence on changing equation model with all constructions and their hypothetical
investment decisions. The association between financial relationships is analysed. Based on the proposed hypotheses,
literacy and behavioural biases in relation with stock five latent constructions are formed, such as heuristic bias,
investments employs structural equation modelling with framing effect, cognitive illusions, herd mentality and
observed variables and latent variables. financial literacy from 15 observed variables. A measurement
SEM is an extraordinary statistical technique for model has been developed to assess the reliability and
inspecting and measuring the causal relationship between validity of the latent variables. Accordingly, its results are
different variables. However, latent variables are not depicted in Figure 1.
directly observable, but mainly derived from other variables. Table 3 depicts that the latent construct captures factor
However, other variables can be directly observed and loadings that are in the range of 0.789 to 0.929, indicating
measured. Structural equation modelling is used for a solid support for the validity of the construct. In this
confirmatory modelling rather than exploratory researches, order, the AVE values extracted for heuristic bias, framing
and is therefore applied to theoretical tests rather than effect, cognitive illusions, herd mentality and financial
development. Structural equation modelling usually literacy are greater than the standard level of 0.50. The
includes two parts, which are the measurement model that composite reliability coefficient values are greater than
explains the association between the latent variables and 0.60 for all latent variables, therefore, high internal reliability
their factor indications and the SEM that transmits the of the model is assured.
causal associations between the latent variables (Fornell & Table 4 depicts that all prerequisites for authorizing a
Larcker, 1981). To forecast the impact of financial literacy first-order measurement model are practically met. The
and behavioural biases of investment decisions in the stock results of the measurement model represent that the chi-
market, the study has developed a conceptual model, which square value is 361.994, with p = .000, CFI = 0.903 and
aims to represent the process of investment evaluation and RMSEA = 0.067. Consequently, the goodness of fit test
support investment behaviour.
Equity share investing behaviour tries to detect the most Table 2.  Results of Correlation Co-efficient Matrix
essential and significant factors in decision-making through
heuristic bias, framing effect, cognitive illusions and herd Heuristic Framing Cognitive Herd Financial
mentality. Behavioural biases are involved with careful Factors Bias Effect Illusions Mentality Literacy
intellectual action of equity investors in order to imply or Heuristic 1 0.889* 0.897* 0.836* 0.792*
not a behavioural bias. In the stock market, investors have bias
to experience different forms of behavioural biases Framing 0.889* 1 0.919* 0.875* 0.781*
effect
in investment decisions. Stock investment decisions of
Cognitive 0.897* 0.919* 1 0.883* 0.808*
individual investors is shaped by the continuation of illusions
behavioural biases and financial literacy. The real Herd 0.836* 0.875* 0.883* 1 0.846*
investment decisions are the resultant activity; hence, it has mentality
been planned to test with the proposed hypotheses. Financial 0.792* 0.781* 0.808* 0.846* 1
Confirmatory factor analysis performed to create literacy
measurement model, which determines perfect fit of the Source: Survey data.
model with data. Reliability of data is primarily estimated, Note: * Significant at 0.01 level.
8 FIIB Business Review

Table 3.  Confirmatory Factor Analysis Results of Measurement Model

Latent Variables Variables Factor Loadings Cronbach Alpha CR AVE

Heuristic bias Anchoring bias 0.929 0.921 0.921 0.764
Overconfidence 0.908
Representativeness 0.887
Framing effect Mental accounting 0.879 0.889 0.885 0.725
Endowment effect 0.873
Regret aversion 0.895
Cognitive illusions Conservatism 0.912 0.874 0.861 0.693
Confirmation 0.884
Hindsight bias 0.796
Herd mentality Information processing 0.928 0.853 0.852 0.687
Bandwagon effect 0.923
Social groups 0.789
Financial literacy Financial competency 0.903 0.832 0.864 0.691
Financial proficiency 0.911
Financial opportunity 0.826
Source: Survey data.
Note: AVE = Average variance extracted; CR = Composite reliability.

Figure 1.  Measurement Model

Source: The author.
Suresh G. 9

Table 4.  CFA Results of Model Fit in Figure 2. From the hypothetical relationship to the
construct, 11 hypotheses have been maintained with path
Chi-square df p CMIN/df CFI RMSEA significant at p = .05 level. Consequently, the study attempted
361.994 126 0.000 2.873 0.903 0.067 to prove that there is a positive and direct association
Source: Survey data. between all the other hypotheses.
Figure 2 exhibits that in the model, amongst the different
hypothetical paths, all paths are significant at p < .05. The
values advocates a practically high fit model. Subsequent research scrutinized the models demonstrated in the graph;
to establishing the reliability and validity of each item, the it makes flow charts for models of equity share investment
model is tested. decisions. Usually, in the structural equation modelling,
the model fit assessed by the chi-square measurement is
Structural Equation Modelling not at all times easy, because it is extremely responsive to
The research hypotheses are tested due to the consistency the sample size. Owing to these constraints, different types
of proposed measurement model with data. The hypothetical of fit indices have been computed and they denote
relationship between the different constructs is presented independent sample size. Therefore, goodness of the fit

Figure 2. Structural Equation Modelling

Source: The author.
10 FIIB Business Review

and the exhaustive link between the different hypotheses
are showed in Tables 5 and 6.
Table 5 depicts the goodness of fit test of the SEM; it
proved the good fit with the data through the use of various
indices. Accordingly the computed value of such indices,
like CFI (0.903), NFI (0.912), TLI (0.919), PNFI (0.921),
PCFI (0.922), RFI 0.913) and IFI (0.904) are higher than
threshold value of 0.9. Further, the values of RMSEA =
0.067 is safely below the threshold value of 0.08, it has
perfect fit with the data. SEM has made a significant
progress with regard to its goodness of fit indices, since
consistency is found on all the suggested values. The
outcome validates the reliability of the statistical test data.
Table 5.  Goodness of Fit Test
S. No Goodness-of-fit
1. Comparative fit index (CFI) - (>0.90)
2. Normed-fit index (NFI) - (>0.90)
3. Tucker–Lewis index (TLI) - (>0.90)
4. Parsimonious normed fit index (PNFI) -
(>0.90)
5. Parsimony comparative fit index (PCFI) -
(>0.90)
6. Relative fit index (RFI) - (>0.90)
7. Incremental fit index (IFI) - (>0.90)
8. Mean square error of approximation
(RMSEA) - (<0.08)
Source: Survey data.
Table 6 represents that heuristic bias brings coefficient
value of 0.795 for anchoring, 0.572 for overconfidence and
0.773 for representativeness. The construct heuristic bias
has positive and significant association with its three ante-
cedents. Put together, all antecedents have contributed to
the existence of heuristic biases in stock investment deci-
sions among individual investors, hence hypothesis (H1) is
accepted. Heuristic bias has a coefficient value of 0.434 for
behavioural biases and it supported that it has direct and
positive association, hence hypothesis (H2) could be
accepted. Therefore, the results are parallel with the
outcome of Jain et al. (2015) and Charles and Kasilingam
(2018). However, heuristic biases are mainly formed with
anchoring, overconfidence and representativeness, and it
creates a certain thumb rule in investment decision-
making. Framing effect has a coefficient value of
Statistics 0.684 for mental accounting, 0.649 for endowment effect
0.903 and 0.815 for regret aversion. The construct framing effect
0.912 has positive and significant association with its antecedents
0.919 and it enthusiastically contributes to form the framing
0.921 effect in stock investment decisions, which then leads to
accept hypothesis (H3). Framing effect has a coefficient
0.922 value of –0.450 for behavioural biases; however, hypothe-
sis (H4) could also be accepted. The results of framing
0.913 effect is similar to the findings of Ritter (2003), however,
0.904
mental accounting, endowment and regret aversion
0.067
together form their own mental calculations in decisions-
making.

Table 6.  Testing of Hypothesis

Un. Coef.
Hypotheses Beta SE Std. Coef. t-value P-value Decision
H1 Anchoring à Heuristic bias 1.000 0.082 0.795 4.498 0.227 Accept
Overconfidence à Heuristic bias 0.732 0.086 0.572 3.642 0.164 Accept
Representativeness à Heuristic bias 1.022 0.089 0.773 5.203 0.197 Accept
H2 Heuristic bias àBehavioural biases 0.511 0.328 0.434 5.328 0.223 Accept
H3 Mental accounting àFraming effect 1.000 0.096 0.684 4.213 0.381 Accept
Endowment effect à Framing effect 0.890 0.102 0.649 3.248 0.248 Accept
Regret aversion à Framing effect 1.138 0.111 0.815 4.236 0.276 Accept
H4 Framing effect àBehavioural biases –0.608 0.411 –0.450 2.985 0.426 Accept
H5 Conservatism àCognitive illusions 1.000 0.225 0.506 4.452 0.452 Accept
Confirmation àCognitive illusions 0.777 0.231 0.311 2.299 0.423 Accept
Hind sight àCognitive illusions 1.750 0.392 0.669 4.878 0.324 Accept
H6 Cognitive illusions àBehavioural biases –0.684 0.497 –0.274 3.625 0.456 Accept
H7 Information processing à Herd mentality 1.000 0.171 0.582 3.544 0.462 Accept
Bandwagon effect à Herd mentality 1.043 0.184 0.601 3.365 0.423 Accept
Social groups à Herd mentality 1.085 0.193 0.581 5.163 0.274 Accept
H8 Herd mentality à Behavioural biases –0.456 0.339 –0.256 3.025 0.473 Accept
H9 Behavioural biases à Investment decisions 0.036 0.058 0.039 4.106 0.247 Accept
H10 Financial competency à Financial literacy 0.044 0.058 0.048 3.524 0.312 Accept
Financial proficiency à Financial literacy –0.107 0.062 –0.108 3.651 0.128 Accept
Financial opportunity à Financial literacy 0.005 0.061 0.005 3.574 0.145 Accept
H11 Financial literacy à Investment decisions 0.051 0.064 0.051 4.245 0.324 Accept
Source: Survey data.
Note: Un. Coef = Un-standardized coefficient; Std. Coef = Standardized coefficient; SE = Standard Error.
Suresh G. 11
Cognitive illusions has a coefficient of 0.506 for
conservatism, 0.311 for confirmation and 0.669 for hindsight
bias. It has been confirmed that cognitive illusions have a
substantial relationship with their antecedents and accept
hypothesis (H5). Cognitive illusions have a coefficient
value of –0.274 for behavioural biases; however, hypothesis
(H6), which deals with cognitive illusions and behavioural
biases is accepted. The findings are similar to Qawi
(2010) and Bakar and Yi (2016), however, conservatism,
confirmation and hind sight bias assists the investors to
follow certain norms in investment decisions. Herd
mentality has significant connection with its antecedents
with coefficient value of 0.582 for information processing,
0.601 for bandwagon effect and 0.581 for social groups;
which leads for acceptance of hypothesis (H7). Herd
mentality has coefficient value of –0.256 for behavioural
biases; therefore, hypothesis (H8) could be accepted. The
results of herd mentality are consistent with Hwang and
Salmon (2004), herd behaviour induces to follow actions
of other in investment decisions. Altogether, behavioural
biases have coefficient value of 0.039 for stock investment
decisions, it directs to accept hypothesis (H9), which
deals with behavioural biases on investment decisions.
This result is alien with the results of Ahmed et al. (2020)
Financial literacy has a coefficient value of 0.48 for
financial competency, –0.108 for financial proficiency and
0.005 for financial opportunity. Financial literacy constructs
have a direct effect on enough financial knowledge in
making investment decisions (Rai et al., 2019). However,
hypothesis (H10) is accepted. Financial literacy has a
coefficient value of 0.051 for investment decisions and has
a positive impact on investment decisions, which leads to
accepting hypothesis (H11). The findings are similar to the
findings of Xia et al. (2014) and Ahmed et al. (2020) that
financial literacy can increase decision-making quality.
The findings corroborated that financial literacy dimensions
and behavioural biases have a direct influence on the
investment decisions of individual investments. With the
intention to test the extent of association among independent
factors in stock market decision-making, the test of
estimates of independent factors has been performed and is
presented in Table 7.
Table 7 depicts that 84.5% differences have been found
between heuristic bias and framing effect. It confirms that
both heuristic bias and framing effect develop a distinct
Table 7.  Estimates of Independent Factors
Variables Variables Estimate
Heuristics bias Framing effect 0.630
Heuristics bias Cognitive illusions 0.075
Heuristics bias Herd mentality –0.162
Framing effect Cognitive illusions 0.007
Framing effect Herd mentality –0.165
Cognitive illusions Herd mentality –0.161
Source: Survey data.
behavioural bias in investment decisions. It also divulges
that an investor assumes either heuristics or frames while
constructing their stock portfolio. Heuristic bias has 18.6%
variation in relation to cognitive illusions. Heuristic
bias and cognitive illusions have a considerable influence
while selecting a particular stock for investment purpose.
Herd mentality of investors can be controlled to the extent
of 28.7% by heuristics bias. Heuristics often controls the
investors to make investments based on the thumb rule
rather than following herd. Framing effect has 2% variation
in connection with cognitive illusions, it shows that an
investor either follow frames or illusions in decision-
making. Framing effect controls the herd mentality in stock
selection to the extent of 33.5%. Similar to that cognitive
illusions detain the investor to follow herding behaviour by
60.4% in selection of investments.
Discussions and Conclusions
The rationale of the study is to examine the influence of
financial literacy and behavioural biases with respect to
irrational behaviour in decision-making. Investors have a
great level of behavioural biases in investment decisions.
Financial literacy helps to assimilate such irrational
behaviour and make effective decisions to attain the desired
profit. Given this point, the study expands the behavioural
approach in decision-making on investments among
individual investors. The study proposed eleven hypotheses,
of which five hypotheses dealt with the antecedents of
heuristics bias, framing effect, cognitive illusions, herd
mentality and financial literacy; four hypotheses measured
its impact with behavioural biases and two hypotheses
addressed the influence of financial literacy and behavioural
biases in investment decisions.
Findings divulged that anchoring bias, representativeness
and overconfidence direct to attain investment decisions
based on earlier incorrect experiences. Heuristic bias can
be highly helpful to make speculative decisions that may
give possible gains or loss in stock investing. It can be
verified that investors mainly rely on such heuristic
information rather than potential investigation and on price
movements of a particular stock. Heuristic bias provides a
few ideas to invest in the stock market and had a positive
impact in developing behavioural biases in investment
SE C. R. R2 P
0.089 7.103 0.845 .001
0.041 1.842 0.186 .065
0.056 –2.918 –0.287 .004
0.034 0.201 0.019 .840
0.051 –3.258 –0.335 .001
0.043 –3.749 –0.604 .001
12
decisions. Framing effect is also a prominent aspect in
creating behavioural bias among individual investors and it
is mostly influenced by mental accounting, endowment
effect and regret aversion. This is the outcome of the
investors’ own techniques and intuitions to buy or sell a
stock. Framing effect makes impulsive behaviour than
rational analysis while planning to purchase a stock. The
premise support that framing effect has significant
influence on behavioural bias.
Cognitive illusions extensively create behavioural bias
in investment decisions. Cognitive illusions are formed by
conservatism, confirmation and hindsight bias in selecting a
stock for investment. The antecedents of cognitive illusions
guide the investors to make a certain pattern of deviation
from rationality in evaluation of investments. Such
precursors have a close connection with creating cognitive
illusions. Cognitive illusions have a strong impact on
behavioural bias. Herd mentality is formed with information
processing, bandwagon effect and social groups in
investment decision-making. However, information
processing provides sufficient information to follow herd
and create bandwagon effect in their decisions. Social
groups make a better environment to compare their own
ideas with others and make decisions accordingly. Herd
mentality of individual investors creates a strong impact in
building behavioural biases. Financial literacy is formed
with financial competency, financial proficiency and
financial opportunity in stock market investments. Financial
competency develops knowledge of investors in various
financial investments. Financial proficiency enhances
investor skills in stock market investments. Financial
opportunity deals with the chance to make investments in
stock market.
Therefore, financial literacy increases an investor’s
knowledge in stock selection, time of purchase or sale, risk
and return estimation without any hesitation. The presence
of financial competency, proficiency and opportunity
develop financial literacy of investors to make profitable
investment decision-making. Behavioural biases are a mix
of heuristic bias, framing effect, cognitive illusions and
herd mentality. It corroborates that investors often follow
heuristics than frames or illusions or herd behaviour in
investment decisions. However, the intellectual potency of
individual investors is mainly influenced by heuristic bias.
That is why; investors often follow the thumb rule as a
significant decision technique than any other technique.
On a few occasions, investors make their own frames based
on their investment knowledge in the market. Sometimes,
investors believe in following existing plans than
developing new ideas to pick shares. Successive failure or
bad experience will induce them to follow herding rather
than developing their own analysis. It is confirmed that
behavioural biases have a strong impact on investment
decision-making.
Both financial literacy and behavioural biases involve
governing investment decisions of individual investors.
Financial literacy guides investors to learn more about
FIIB Business Review
the investment environment, but behavioural biases
provide simple and effortless ideas for decision-making.
The independent relationship between variables found that
heuristic bias has significant positive impact with the
framing effect and cognitive illusions in decision-making,
but it has negative impact with the herd mentality.
The framing effect has a positive impact with cognitive
illusions but has a negative impact with the herd mentality.
Cognitive illusions have a negative impact on investors’
herd mentality in decision-making. It can be concluded
that individual investors follow irrational behaviour in
investment decisions with the active presence of financial
literacy in the stock market.
Research Implications
The findings also provide the following implications for
academics and experts. Individual investors find it difficult
to value a security while deciding to buy it. The movements
of stock market prices are unpredictable for everyone;
investors develop their own ideas or imitate others to make
better decisions in the stock market. Investors often develop
their own ideas based on a thumb rule, personal calculations
and follow past experiences to make better decisions.
Effective decision-making helps individual investors
maximize their return on their investment. The success of
investing in the stock market is based on their ability to
learn the dynamic market environment and develop
appropriate investment strategies. Proper investor education
through training can increase their ability to learn the stock
market. Due to the lack of training, investors create an
irrational approach to make investment decisions. However,
irrational decisions guarantee short-term gains, but it is not
good to make profitable decisions from a long-term
perspective. Academics, policymakers and experts should
strive to provide training and development measures to
help investors make rational decisions.
Limitation and Future Scope of
Study
Like other studies, this study also has its own limitations.
First, this study is conducted in South Indian states, hence
it may not be generalize to other parts of country. Second,
this study collected data using google form hence the
respondents may be wrong on recalling their behavioural
bias while responding. Third, limitation is to examine each
individual bias—say anchoring bias—was estimated using
only one variable, while it can examine using number of
variables like other study. This study used financial literacy
factor as predicting variable rather than mediating variable,
a similar kind of study can be made using the financial
literacy as a mediating factor in between the behavioural
bias and investment decision.
Suresh G. 13
Acknowledgement
I thank Dr M. Banu Durukan Sali Dokuz, professor in
Finance, Eylül Üniversitesi/Dokuz Eylul University, Turkey,
and my colleagues Dr Anand Sankar Raja, Dr Akansha
Kanna, from CHRIST (Deemed to be University), assistant
professor in Marketing, who provided an insight and
expertise that greatly assisted the research, although they
may not agree with all of the interpretations and conclusions
of this article. I would also like to show my gratitude to
Dr Jothi Munusamy, associate professor, CHRIST university,
for sharing his pearls of wisdom with me during the course
of this research.
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect
to the research, authorship and/or publication of this article.
Funding
The author received no financial support for the research,
authorship and/or publication of this article.
ORCID iD
Suresh G. https://orcid.org/0000-0002-0409-4599
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About the Author

Suresh G. is an Assistant Professor and Research Supervisor in the commerce department at CHRIST
(Deemed to be University), Bangalore. He has more than 12 years of experience and published 20 research
papers in Scopus, EBSCO, ProQuest and UGC listed journals and published a book. He is also an active
reviewer of the NETNOMICS journal, SAGE Open journal. He is currently doing research in the areas
of, behavioural finance, FinTech and risk management in financial institutions. He can be reached at
suresh.g@christuniversity.in

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