Financial literacy, Cognitive bias, And personal investment decisions: A new perspective in behavioral finance

Abstract

This study investigates the complex relationships between financial literacy, cognitive biases, and investment decisions among individual investors. Using a sample of 2,000 participants, we employed multiple regression analyses and mediation tests to examine these relationships. Our findings reveal that financial literacy has a significant positive direct effect on investment decision quality. However, this relationship is partially mediated by various cognitive biases. Higher financial literacy is associated with reduced susceptibility to availability bias and herding behavior, but shows a positive correlation with overconfidence bias. Interestingly, we observed a non-linear relationship between financial literacy and confirmation bias. The mediation analysis indicates that cognitive biases account for 40% of the total effect of financial literacy on investment decisions, with herding behavior and availability bias showing the strongest mediating effects. Our results suggest that while financial literacy is crucial for improving investment outcomes, its effectiveness is moderated by cognitive biases. These findings have important implications for financial education programs and policy initiatives, highlighting the need for a more comprehensive approach that addresses both financial knowledge and cognitive biases. This research contributes to the behavioral finance literature by providing empirical evidence of the intricate interplay between financial literacy, cognitive processes, and investment outcomes, and suggests directions for future research in developing more effective strategies to enhance individual investors' decision-making capabilities.