An Irrational Investment Decision Making

Introduction

Investments are funds commitments to one or more assets to be held for a period in the future, with an expectations that these assets will result in higher revenue. For investments involving financial assets such as stocks, there are many factors that need to be emphasized when making an investment selection. The wise investor will take into account such factors the company's background and its management, the company's financial strength, the procurement price ratio and dividend yield, earnings growth prospects and the ability of companies to compete. According to Aruna & and Rajashekar (2016) many literature reveal that there is no single factor influencing investment decisions of an individual. The investment decisions may vary accordingly base on the period of study, different places, different securities, different investors and etc. Making investment decisions is complicated that sometimes investors make irrational decisions in their investments.

Jahanzeb, Muneer & Rehman (2012) associate this decision-making process as a unique skill to choose the best alternative from the various alternatives available because the behavioral finances do not assert that every investor will experience the same illusion, thus makes it difficult to take the necessary plans to avoid risk that affect the decision-making process in investment. Muhammad and Abdullah (2009) believed that each retail investor has a unique way of determining their investment products, even though there are some retail investors who may invest without making any reasonable judgments. Most of them make an investment decision depending on the financial goals, availability of resources and the profit period to be achieved. However, there are some retail investors who often make irrational decisions on choosing the right stocks to invest. According to conventional monetary theory, investors are very rational, but in the real world, they are influenced by many factors, including psychology and behavior, which impede rational decision-making (Rasheed et. al, 2018).

Literature Review

Previous researched has identified several factors that were considered as the influencing factors of the irrational investment decisions of retail investors. Significant factors include past experiences, cognitive biases, escalation of commitment and sunk outcomes, individual differences including age and socioeconomic status, and a belief in personal relevance. All these factors affect the decision making process and the decisions made by the retail investors. Following discussion will examine the factors that may affect the behavior of investors and how they make irrational decisions regarding investment.

Representative Bias

Kahneman & Tversky (1979) stated that representative bias is when that investors use mental short cut which decision are based on probability judgments of the outcomes that systematically contravene Bayes’ rule. Waweru (2008) believed that these judgments were quite useful, particularly when time is limited (Waweru et al. , 2008, p. 27), however occasionally the decisions tend to biases (Kahneman & Tversky, 1974). The study by Ramdani (2018) found that the representative bias have a positive influence on investment decision among the younger investors in Yogyakarta. They assume that good performance of stock previously will continue in the future. However, their evaluation of the stocks prices information are not wisely use and analyzed accordingly to cause investors often wrong in making decisions.

Availability Bias

Beside representative bias, another factor that cause the irrational investment decision is availability bias. Tversky & Kahneman, (1973) and Folkes (1998) and define the availability bias as a decision making made by the retail-investor where the decision depend on knowledge that is readily accessible relatively than inspecting other alternatives and procedures that have causes decisions to be irrational. Thus the investment decision will change accordingly to the availability of the information (Harris & Raviv,2005). The effect of the availability bias also can be witnessed from the way of investors select the stocks to be included in their portfolio (Waweru et al. , 2008) and the perception of the investors to believed that stock with lower risk considered as stock a good stock to invest and vise versa (Ganzach, 2000). The investors prefer to invest in local companies with which the investor is more familiar or where information about them can be easily obtained. Meanwhile, Khan (2015) has proved that availability bias and investment decision has negative correlation. The researcher use the convenience sampling of real stock investors of Islamabad stock exchange graduate and post graduate students whose well financial knowledge.

Active trading

Haritha & Uchil (2016) observed that an active trading is considered as speculative investment which seeks to take advantage of price anomalies in short-term movements and often established on financial securities in higher demand, for example currencies, stocks, options, and derivatives. The active traders perceived that an average long-term return not as an achievable expectation thus believed the potential profit in the markets should be looked upon to outperform the markets. However, the earlier study revealed that active trading traps where it was found that active traders underperform in the market and active trading correlate with too much confidence (Merton,1987).

Loss Aversion Bias

Loss aversion refers to the propensity of the individuals who are more sensitive to the decline in their capital compared to a chance of growth in their investment (Khan, 2015). Therefore, their concern are more on protecting from capital losses than to profit and a tendency to evaluate outcomes frequently. Unlike availability bias, Khan (2015) found that loss aversion is positively related with the investment decision.

Objective of the Study

The study only focus to retail or individual investors. The objective of this study is to determine the various factors influencing the irrational investment decisions of a retail investor. Also to give suggestion to the concern parties such as the investment providers and the policy makers, to generate many innovative investment channels based on factors affecting the investment decision of retail investors.

Methodology of the Study

This study is conceptual approach thus, the study is based on the secondary sources of data collected from research articles, journals, magazines, and research websites etc.

Conclusion

To date, behavioral finance is increasingly gaining attention among researchers as it also relates to investor behavior in decision-making. Based on the above discussion, it is clear that retail-investment is not only influenced on certain factors, but by various factors including demographic, economic, social and psychological factors of an investor. The most crucial part in retail-investment is to make a rational decisions at the critical moment in which the investor would act in accordance with their instincts and emotions at that time. The studies of behavioural finance explain why an investor makes an irrational investment decision.

The cause of this emotional uncertainty is due to such factors as being too confident, less sensitive or overly sensitive to changing market environment and losing control over the investment goals. This paper conclude that the investors’ decisions depends on the ability of the investors to analyse and interpret the information that available to them and how much their willingness to absorb certain risk while making decisions. Basically, the behavioural finance investigates investor behavior patterns and tries to understand how this pattern could help to make a better investment decisions.