Analysis Of Cognitive Biases in Investment Decision-Making - An Investor Perceptive

Abstract

Purpose

The main objective of this study is to examine how different types of biases affect investment choices. Investment choices play a crucial role in an individual’s financial well-being and long-term wealth accumulation. However, these decisions are often not purely rational and are significantly influenced by a range of behavioral biases. Behavioral finance, a field that merges psychology with traditional finance, seeks to understand how cognitive and emotional factors affect investors' decision-making processes.

Design/methodology/approach

This study aims to examine the different types of behavioral biases that affect investment choices. By identifying and analyzing these biases, we can better comprehend their impact on individual and market-level behaviors. Ultimately, this research seeks to provide insights that can help investors recognize their biases and adopt more rational investment strategies, enhancing their potential for financial success.

Findings

Many investors overestimate their knowledge and ability to predict market movements, leading to excessive trading and increased risk-taking. Studies show that overconfident investors often underperform due to poor decision-making.Investors tend to fear losses more than they value gains, which can result in holding onto losing investments longer than advisable (the disposition effect). This behavior can lead to suboptimal portfolio management. Investors often rely too heavily on initial information or specific price points when making decisions, even if that information becomes irrelevant. This can affect buy/sell decisions and lead to missed opportunities.

Originality 

These biases can lead to suboptimal investment decisions, such as excessive trading, failure to diversify, or holding onto losing investments for too long. Suboptimal outcomes of investment are triggered from the irrationality of investor decisions. The irrationality is due to psychic issues. Limited research was carried out due to the lack of awareness and focus in the behavioral and prospect biases. For improving the awareness and to educate investors a clear study is required for strategic investment planning and optimizing the outcomes of investments.

Research limitations/implications

Many studies may rely on small or homogenous samples, limiting the generalization of findings across different demographics, such as age, gender, socioeconomic status, and geographical location.Research often depends on self-reported data from investors, which can be influenced by social desirability or lack of self-awareness. This can lead to inaccuracies in understanding the extent of biases. Establishing causal relationships between cognitive biases and investment decisions can be challenging. Many studies can only demonstrate correlation, leaving the underlying mechanisms unclear.

Practical implications

The present study is framed with two broad sets of dependent and independent variables, two sets of independent variables i.e. Behavioral Biases and Prospect Biases and each of these independent variables are chosen with four biases each and single dependent variable i.e. Before making an investment, researchers must determine whether independent factors have an effect on the dependent variable. Each of these variables is framed with four questions each. The responses are analyzed with SPSS

Social implications

The expected optimal return is possible with the awareness in investors where decision making strategies will be improved and psychological errors will be mitigated. This behavior is going to build much value for the bull market, during the bear market, herding can exacerbate sell-offs, due to which a steep decline in a stock price will take place. To avoid the adverse impact of herding investors should make independent decisions based on fundamentals and their own analysis.