Empirical Study on Financial Literacy, Investors’

Personality, Overconfidence Bias and Investment

Decisions and Risk Tolerance as Mediator Factor
Shahid Hussain 
(

[email protected]
)
Khwaja Fareed University of Engineering & Information Technology
https://orcid.org/0000-0003-3855-
3244
Abdul Rasheed 
Khwaja Fareed University of Engineering & Information Technology

Research Article

Keywords: Behavioral Finance, Investors, Financial Literacy, Investment Decisions, Emerging Markets

Posted Date: September 27th, 2022

DOI: https://doi.org/10.21203/rs.3.rs-2005225/v1

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Abstract
The key objective of this research paper is to estimate the impact of financial literacy, investor’s
personality and overconfidence bias on investment decisions by using risk tolerance as a mediator
variable. Inclusive finance makes numerous financial products and services accessible and affordable to
the micro-finance community, remarkably those absent from the conventional financial system. Financial
literacy is a leading factor affecting an individual's ability to access financial services. This study
employed Structural Equation Modeling to investigate whether financial literacy and other personality
traits affect investment decisions. The Regression results showed that financial literacy, investors'
personality, and overconfidence bias are significantly relevant to risk tolerance and investment decisions
(β = 0.128***, S.D = 0.047, t = 2.746; p < 1%; β 0.378***, S.D = 0.051, t = 7.414, p < 1%; β 0.269***, S.D = 
0.052, t = 5.155, p < 1%; β 0.195***, S.D = 0.054, t = 3.619, p < 1%; β 0.371***, S.D = 0.055, t = 6.706, p < 1%;
β0.195***, S.D = 0.061, t = 3.190, p < 1%). As mediation results showed, risk tolerance plays a significant
role in financial literacy, investors' personality, overconfidence bias, and investment decisions (β = 0.024**,
S.D = 0.011, t = 2.15, p < 5%; β = 0.024**, S.D = 0.011, t = 2.17, p < 5%; β = 0.047**, S.D = 0.018, t = 2.55, p < 
5%). The implications of this study also provide valued recommendations for regulatory institutions to
improve financial inclusion in the emerging market context.

JEL Classification: G40, G41

Introduction
Financial inclusion promotes access to financial services, and it directly connects with the growth of the
financial system (Kabir Hassan, Unsal, and Emre Tamer 2016). The main hurdle to inclusive finance is
financial illiteracy (Kubilay and Bayrakdaroglu 2016; Ahmad and Shah 2020; Kalsum et al. 2018).
Investment decision-making is a critical and sensitive process because personal biases and traits vary in
each investor. Xue et al. (2021) finds several crucial choices that influence investors’ judgment. He argues
that the decision-making process becomes more manageable when most complexities are known to
investors, which causes a reduction in financial losses.

Corporate analysts, institutional and retail investors face several challenges, such as market volatility,
regulatory inconsistencies, uncertainty in economic situations, and fullness of choice when making
investment decisions (Nguyen et al., 2016). Rational investors must be aware of the risks involved in their
financial decisions. Alternatively, decisions based on insufficient or ambiguous information and imperfect
data evaluation tend to lead to spurious results (Ullah et al., 2017). The investors must choose their
investment hazard centred on the trends that the investors find. Details may be needed if other clues
change the decision, or the evidence may be vain (Pak and Mahmood, 2015). The amount of evidence
comes from how the decision-maker uses it for investment. A knowledgeable decision-maker may ever
act as an informant regardless of the details (Worthy et al. and Xiao et al., 2018). Expert investors may

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make the right investment decision by creating self-confidence or using knowledge or risk management
suitably (Sivarajan and Bruijn, 2021).

In the extant literature, several studies investigate the factors such as financial well-being, herding
behavior, and investment intention that influenced the investors' investment decisions. Yang et al.
(2021), Masenya & Dickason-Koekemoer (2020) and Shusha (2016) examined financial well-being (Yang
et al., 2021; Papapostolou et al., 2017; Camara, 2017; Haghani & Sarvi, 2019) studied the herd behavior,
and (Shim, Lee, and Kim 2008; Azizah and Mulyono 2020) assessed the investment intention. On the
other hand, financial literacy, investors' personality, and overconfidence bias are also essential forces of
investment decisions (Bayar et al. 2020; Kannadhasan et al. 2016; Nguyen, Gallery, and Newton 2016;
Anshika, Singla, and Mallik 2021; Arianti 2018). Therefore, very little attention has been paid to risk
tolerance as a mediator factor during the investors’ investment decision-making.

Pakistan has a population of more than 200 million. Still, penetration in access to financial services is
shallow, with only 3% and 25% of the population having access to credit and bank accounts in the
banking sector. Lack of awareness of financial products, lower per capita income and poor financial
management skills are the critical reasons for the unbanked population in Pakistan. The State Bank of
Pakistan (SBP) regularly conducts surveys and launches a national financial inclusion strategy (NFIS)
program to weigh the state of financial inclusion. SBP initiatives' performance and demand-side trends
use a range of quality payments, savings, credit and insurance services that meet their needs with dignity
and fairness (Ibrahim and Rizvi 2018). The banking sector of Pakistan consists of 53 banks with a
16,076 branch network and has 57 million bank accounts holder.

This study aims to investigate the impact of financial literacy, investors' personality, and overconfidence
bias on investment decisions while using risk tolerance as a mediating factor. Due to higher political and
economic instability in the economy, investors required more diligence while making investment
decisions (Awais et al., 2016). The SECP and SBP are the central regulators of the financial system in
Pakistan due to consistent changes in regulatory policies, which hurt investors' decision-making
processes (Chavali and Mohanraj, 2016). 

This research makes three contributions to fill the theoretical and empirical gap of the extant literature.
First, we document the quantitative impact of financial literacy, investors’ personality and overconfidence
bias on investment decisions using structural equation modeling. Second, this study provides several
paradigms of financial inclusion that how investors’ can access financial services and promote financial
literacy. Third, this study also explores various avenues for future research on adding value to relevant
literature.

This study divides into five sections as Section-II will present the literature review, section-III will provide
the research methods. Then section-IV will present the results and discussion, and the last Section-V will
provide the conclusion, limitations, and suggestions for future research.

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1. Literature Review
1.1 Financial Literacy and Risk Tolerance

Financial literacy is considered to be an essential skill for people to increase their economic prosperity.
Lack of financial information leads to poor financial choices that are harmful to individuals and society
as a whole (Kannadhasan et al., 2016). A good correlation between financial literacy and the
accumulation of wealth, savings and retirement planning is established in several studies (Dickason and
Ferreira, 2018). Kumari (2020) concludes that financially literate students showed a more positive
attitude towards the financial risk than financially illiterate students. Masenya and Dickason-Koekemoer
 (2020) argue that people with a low level of financial literacy would experience a high level of difficulty in
understanding financial concepts, and this often has complete problems. Bayar et al. (2020) conjecture
that people with more financial experience could have better-distributed finances. Akims and Jagongo
(2017) examine that persons with an upper level of financial literacy earn high scores on absolute risk
and vice versa. According to Janor et al. (2016), households with low levels of financial literacy tend to be
particularly vulnerable. Nur Aini & Lutfi (2019) identify a significant connection between risk tolerance
and financial literacy.

H1: Financial literacy positively affects risk tolerance.

1.2 Investors' Personality and Risk Tolerance

Personality denotes how a distinct individual interacts, responds, and acts with others and is frequently
shown through quantifiable characters. It affects the risk-taking behavior in different choices of an
individual's life and societal, betting, and investment decisions (Dickason and Ferreira, 2018). Extant
literature investigates that, in ambiguous situations, investors' personality guides an investor’s decision-
making attitude. Pak and Mahmood (2015) employ the BFF model to clarify human attitude, risk-taking
tendencies, and investment decisions in changed situations. They find that talkative persons are friendly,
courteous, sincere, and are not inevitable by rationality or moralities. They are further disposed to be
directed by external touchable stimulators and, subsequently, take risks more thoughtlessly than a shy
person. They are outward and more optimistic about life and trials. Ullah et al. (2017) find that investors
acquire financial advisory then take favorable or progressive decisions. Nguyen et al. (2016) argue that
optimistic behaviors about lifespan and events can raise the over-assessment of the market and under-
assessment of potential risks. Alternatively, adverse behaviors and thin attention cause over the
assessment of hazards and lead to the loss of gainful investment prospects.

H2: Investor's personality positively influenced to risk tolerance.

1.3 Overconfidence Bias and Risk Tolerance

It is challenging for investors to have balanced when making investment decisions and categorized them
based on their risk profiles such as risk-taker and risk-averse (Sivarajan and de Bruijn, 2021). Pradikasari
and Isbanah (2018) incorporate the behavior of Indian investors who invest in several instruments based
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on (i) from a fundamental point of view, (ii) a theory of self-awareness, (iii) a public opinion, and (iv) an
individual's perspective. Chavali and Mohanraj (2016) investigate the behavior of investors in the Indian
stock market and determine that investors set their savings targets, identifying savings factors and
decision-making resources. The books speak volumes about self-confidence, leading to irrational
investment decisions (Aini and Lutfi, 2019). They also discuss the various risk tolerance levels for
investors that can lead to a change in investment strategy. Raheja and Dhiman (2019) find that most
research on risk tolerance is done from a traditional and financial side, not from an ethical-financial
perspective.

H3: Overconfidence bias positively influenced risk tolerance.

1.4 Financial Literacy and Investment Decisions

Financial literacy is a critical factor in the investment decision-making process. Financial literacy is a
procedure for controlling finance in budgeting, investments, financial savings, financial planning, and any
type of insurance (Kanagasabai and Aggarwal, 2020). In monetary terms, literate people may control their
reserves effectively (Chavali and Mohanraj, 2016). It is a degree to which one can understand basic
financial concepts and manage one's finances (Akims and Jagongo, 2017). Financial literacy is
obligatory for investment decisions in financial institutions where many young generations wish to have
financial limitations (Akims and Jagongo, 2017). Moreover, the study indicates that are wellness
insurance, and awareness in investment, budget, and savings are essential in financial education. The
amount of financial information should reflect the reasonable lifestyle of the people (Gherzi et al. 2014). 

H4: Financial literacy positively impacts investment decisions.

1.5 Investors' Personality and Investment Decisions

Because of the consequences from tests made in sequence to assess the investors' personality, the
investors' personality and investment portfolio wanted to be generated may be understandable (Yong and
Tan, 2017). So, this will reduce the confusion and poor judgment for the instructions that specialist
investors who are business advisers will give, just allowing for the spiritual preference of
investors (Aeknarajindawat 2020). Without scientific research, it is impossible to test investors' various
characteristics within a strategic framework to develop an ideal investor profile. The reason is that
markets have distinct features, and the personality traits needed for investment attainment differ from
individual to individual. In addition, the achievement of specific persons in different markets has counted
among the justifications (Dickason and Ferreira, 2018b). Personality plays a vital role in investment
decisions because behavior leads to personality, and a person's behavior towards decisions is a
compulsory item in investment decisions (Pak and Mahmood, 2015).

H5: Investors' personality is positively influenced by investment decisions.

1.6 Overconfidence Bias and Investment Decisions

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Another aspect of ethical bias that has received much attention from analysts in the financial division is
overconfidence (Aini and Lutfi, 2019). Overconfidence is absurd confidence based on mood motivation,
self-examination, and mental talent. Overconfidence makes a person's sense smoother and better
informed so that when an individual guesses an incident to feel he is sure of, the truth is often less than
expected (Aini and Lutfi, 2019). An overconfident person will tend to skip information gained because
they rely too much on their beliefs, are too self-confident, and rely on their ideas and knowledge to ignore
other relevant information. The adverse effects of overconfidence can make a person make a worse
decision than they should have (Pradikasari and Isbanah, 2018). Earlier literature finds that overconfident
investors are making many business transactions (Raheja and Dhiman, 2019). An overconfident person
is often more confident in making investment decisions and distributing money to high-risk properties
because of the level of self-reliance that supports them (Bayar et al. 2020).

H6: Overconfidence bias positively influenced investment decisions.

1.7 Risk Tolerance as a Mediating Factor

Risk tolerance is the level of a person's readiness to admit invested risks. It also means how one responds
and takes action on investment risk. Aeknarajindawat (2020) argues that the level of risk tolerance can be
classified as a risk-seeking person, neutral in risk, and dangerous. Risk tolerance may help an individual
to cognize the intensity of risk from investments and support the person to be up to tolerate and adapt
the risks involved to meet the investment aims so that the risk that the person is eager to agree to take
will match the level of future return (Nguyen et al., 2016). Risk tolerance influences investors' decisions in
alternative investment options. A person with a higher risk tolerance can invest in higher-risk assets, while
a low-risk tolerance tends to avoid high-risk assets (Sivarajan and de Bruijn, 2021). According to our
hypothecation, risk tolerance is also a vital mediating relationship between financial literacy and
investment decisions. It is also shown in many types of research that financial literacy directly influenced
investment decisions. Empirical evidence shows that financial literacy indirectly impacts investment
decisions when risk tolerance is used to mediate between them (Aini and Lutfi, 2019). When an investor
knows investment procedures through bank accounts, he is known as financial literate; then, he can also
make investment decisions (Bayar et al. 2020). 

Extant literature argues that investment decisions directly influence the Investors' personality and find a
positive association when risk tolerance is used as a mediator. Perveen et al. (2020) claimed that
personality traits positively affect investment decisions and anxiety negatively impacts investors'
behavior. Overconfident investors tend to skip information when they have gained based on their personal
beliefs and self-confidence and rely on their ideas and knowledge to ignore other relevant information.
The adverse effects of overconfidence can make a person make a worse decision than they should
have (Pradikasari and Isbanah, 2018). Overconfident financial investors believe that they can earn higher
profits and face minimum risks when investing, although this is unreliable and not possible (Raheja and
Dhiman, 2019).
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H7: Financial literacy, Investors’ Personality and Overconfidence bias positively affect the investment
decision with mediating role of risk tolerance.

H8: Investors’ Personality positively affects the investment decision with mediating role of risk tolerance.

H9: Overconfidence bias positively affects investment decisions with the mediating role of risk tolerance.

1.8 Theoretical Framework

The fundamental purpose of this study is to examine the impact of financial literacy, investors'
personality, and overconfidence bias on investment decisions using risk tolerance as mediating factor.
This study followed two theories; decision and risk theories (Waheed et al., 2020). The decision theory
argues how rational investors behave under uncertainty and adopt rational choices for efficient
management of investments. Risk theory deals with risk management and analytical processes that
measure the potential volatility to predict risk-avoiding, mitigation better or pursue.

2. Research Methodology
2.1 Research Procedures and Sample description

The sample of this research consists of 901 participants from the major metropolitan and industrially
developed cities of Punjab, Pakistan. Punjab is the largest populated and most industrialized province of
the country, having a higher literacy rate and a significant contributor to economic growth. This study
excludes 16 responses due to inappropriate information. The entire data collection was made through the
random sampling process. In order to collect pertinent responses, we selected the respondents of 18
years’ age or above, having a bank account and must have an earning source. We have collected data of
respondents’ age, academic qualifications, gender and level of income from the investors and workers
who have invested in any asset class. 

The questionnaire was developed after a thorough review of the literature, scales and reports. The
components of this study are presented in Figure 1. The financial literacy, investors’ personality,
overconfidence bias and investment decision components were measured through every four items and
followed by (Kanagasabai and Aggarwal, 2020), (Dickason and Ferreira, 2018), (Aini and Lutfi,
2019) and (Haseeb W. et al., 2020) respectively. The risk tolerance component was measured through five
items and adapted from (Hermansson and Jonsson 2021). The questionnaire was designed to
investigate the impact of financial literacy, investors' personality and overconfidence bias on investment
decisions using risk tolerance as a mediating factor. All components were measured using the Likert
Scale of "strongly disagree” = 1 to “strongly agree” = 5. The survey was conducted by distributing Google
forms link to collect the data. The operational definitions and measurement methods of each variable are
presented in Table 1.

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 Table 1: Variables Measurement & Definitions

Control Definitions & Measurement Techniques

Variable

Age The age of the respondents is divided into five groups as G1 if respondent’s age is
less than 20 years, G2 if respondent’s age is from 21 to 30 years, G3 if
respondent’s age is between 31-40, G4 for 41-50 and G5 for above 50 years.

Gender Gender of the respondents (Male=1, Female=2, Prefer not to say=3)

Education The academic qualification of respondents (Primary=1, Matric=2, Graduation=3,

Post Graduate=4, Doctorate=5, Prefer not to say=6)

Income The level of income range of respondents per year in PKR (Below 500,000=1,
500,001-1,000,000=2, 1,000,001-2,000,000=3, Above 2,000,000=5)

Other Variables  

Financial Knowledge of the financial instruments (Rooij 2012) was measured by using a 5-

Literacy points Likert scale (1=Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree,
5=Strongly Agree)

Investors' Personality refers to the way a person communicates, responds, and behaves (Pak
Personality and Mahmood 2015), which is measured by using a 5-points Likert scale
(1=Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree, 5=Strongly Agree)

Overconfidence An unnecessary belief in one's rational thinking, judgment, and perceptive

Bias powers (Mishra and Metilda, 2015) is measured by using a 5-points Likert scale
(1=Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree, 5=Strongly Agree)

Risk Tolerance The level of uncertainty is that an investor can tolerate reaping huge profits
 (Raheja and Dhiman, 2019), which is measured by using a 5-points Likert scale
(1=Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree, 5=Strongly Agree)

Investment A decision made by investors or senior executives regarding the amount of money
Decisions that will be spent on investment opportunities (Perveen et al. 2020) is measured by
using a 5-points Likert scale (1=Strongly Disagree, 2=Disagree, 3=Neutral, 4=Agree,
5=Strongly Agree)

2.2 Econometrics Techniques

Structural equation modeling (SEM) is employed to investigate the associations between variables. This
method is a mixture of multiple regression analysis and confirmatory factor analysis (CFA), used to
determine whether the covariates are significantly related to their factors or not. Partial least squares
(PLS) structural equation modeling has widely appeared in two ways as (1) goodness of measures and
(2) examining the research model (Perveen et al., 2020). In order to investigate the impact of financial
literacy, investors’ personality and overconfidence bias on investment decision using risk tolerance as
mediating factor, we employ the following multiple regression equations. First, we employ Anshika et al.,
(2021) methodology to test the H1, H2 & H3 as;

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Decision-making theory is a theory of how rational investors should behave under risk and uncertainty.
Decision-making indicates the adoption and application of rational choices for investment management
in an efficient manner. In order to pursue hypotheses H4, H5 and H6, to investigate the impact of financial
literacy, investors’ personality and overconfidence bias on investment decision-making, we follow the
Anshika et al. (2021) methodology by using the following equation:

Where in equation (2),  is a dependent variable. The operational definition is presented in Table 1 used to
check the direct impact of independent variables on a dependent variable (investment decisions). i
indicates the number of respondents of the study. 

In order to analyze the risk tolerance mediating role in the financial literacy, investors' personality,
overconfidence bias and investment decisions, we employ the Skagerlund et al., (2018) methodology to
test the hypotheses of H7, H8 and H9 by using the following equation: 

3. Results

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3.1 Summary of Respondents' Profile

After collecting and analyzing the respondents’ information, Table 2 presents the detailed sample
distribution of respondents’ profiles. We divided the age and education of respondents into five groups
while income into four groups. More than 87% of respondent investors’ age are between 31 and 50 years,
and they have access to financial services offered by banks, mutual funds, insurance companies and
brokerage houses. Near 86% of respondents are male and 14% female. More than 85% of respondents
had a higher graduation education level and indicated that most investors with investments in various
financial instruments are highly qualified. The majority of investors had an income between PKR 500,000
and 2,000,000. 

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 Table 2: Summary of Respondents' Profile used in this study

Variables Category Frequency Percentage

Age Below 20 years 16 1.8

21 to 30 years 98 10.9

31 to 40 years 620 68.8

41 to 50 years 145 16.1

Above 50 years 22 2.4

Gender Female 127 14.1

Male 774 85.9

Education Primary 4 .4

Secondary 98 10.9

Graduation 400 44.4

Post Graduate 362 40.2

Doctorate 34 3.8

Prefer not to say 3 .3

Income (Yearly) 0 to 500,000                  (Below USD=3,165) 48 5.3

500,001 to 1,000,000    (USD=3,165 to USD=6,329) 528 58.6

1,000,001 to 2,000,000 (USD=3,165 to USD=12,658) 237 26.3

Above 2,000,000          (Above USD=12,658) 41 4.5

Prefer not to say 47 5.2

Source: Calculation from collected data by author

 3.2 Structural Equation Modeling (SEM)

The present research employed the Smart PLS application to estimate the SEM technique using
measurement model assessment and structural model assessment steps. A two-step process of PLS-
SEM path model assessment was followed by (Henseler, Ringle, and Sinkovics 2009). 

3.2.1. Assessment of Measurement Model

First, the PLS-SEM was employed to evaluate the assessment of the measurement model followed
by (Henseler, Ringle, and Sinkovics 2009). The reliability of each item was assessed by observing the

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outer-loadings of each item (Hair et al., 2014). The internal consistency was measured using Cronbach's
alpha and composite reliability estimates (Hameed et al. 2020). The convergent validity of each item was
calculated using the AVE (Hameed et al. 2020). This research tested composite reliability, factor loadings,
AVE, and discriminant validity (Hair et al., 2014) methodology.

           Table 3: Results of Internal Consistency, Composite Reliability, and AVE tests

Variable Cronbach’s Alpha CR AVE N

Financial Literacy 0.931 0.881 0.749 901

Investors’ Personality 0.889 0.721 0.694 901

Overconfidence Bias 0.776 0.753 0.737 901

Investment Decision 0.763 0.899 0.718 901

Risk Tolerance 0.813 0.728 0.708 901

On the other hand, to achieve the slightest range of convergent validity, factor loading should not be
lesser than 0.5 (Hair et al., 2014). In existing research, the factor loading of each item is more significant
than 0.5, as presented in Table 3. Moreover, composite reliability and AVE should correspond to greater
than 0.7 and 0.5 (Hameed et al. 2020). As stated in Table 3, AVE and composite reliability are greater than
0.5 and 0.7. The discriminant validity is tested using Henseler et al. (2015) methodology. Correlations
among variables are matched with the AVE square root (Gartner et al.). It is presented in Table 4.

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 Table 4: Results of Discriminant Validity using FLC method

Variables 1 2 3 4 5 6 7 8 9

Age 1.000                

Gender 0.077 1.000 0.015   -0.019 0.014      

Education -0.037   1.000   0.059 -0.011      

Income 0.051 -0.039 -0.040 1.000 -0.068 -0.062      

Financial 0.159       0.591        

literacy

Investment 0.151       0.544 0.639      

Decisions

Investors’ 0.072 -0.036 0.049 -0.011 0.524 0.654 0.628    

personality

overconfidence 0.116 -0.032 0.004 -0.061 0.543 0.691 0.684 0.661  

bias

Risk tolerance 0.073 -0.021 0.079 -0.055 0.586 0.538 0.526 0.533 0.563

Note. 1,2,3,4,5,6,7,8, and 9 are used for age, gender, education, income, financial literacy, investment
decisions,
 investors' personality, overconfidence bias, and risk tolerance.

3.2.2. Assessment of Structural Model

The structural model assessment was tested using Smart PLS3 comparable with (Hair et al.,
2014; Henseler et al., 2009). In this method, first, to investigate the direct association among each
variable and the indirect impact of the mediating role of risk tolerance has been examined. Second, the
size effect (f2) and predictive relevance (Q2) were examined to evaluate the model quality.

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 Table 5: Measurement Model Assessment Direct Effects and Decisions

Hypothesis Relationships Coeff. S.E t stat Decisions

H1 Financial Literacy -> Investment Decisions 0.128*** 0.047 2.746 Accepted

H2 Financial Literacy -> Risk Tolerance 0.378*** 0.051 7.414 Accepted

H3 Investors’ Personality -> Investment 0.269*** 0.052 5.155 Accepted

Decisions

H4 Investors’ Personality -> Risk Tolerance 0.195*** 0.054 3.619 Accepted

H5 Overconfidence Bias -> Investment 0.371*** 0.055 6.706 Accepted

Decisions

H6 Overconfidence Bias -> Risk Tolerance 0.195*** 0.061 3.190 Accepted

Note: *, ** & *** indicates the level of significance at 10%, 5% & 1% respectively
 

The findings of assessments of the measurement model are presented in Table 5. The findings indicate
that financial literacy has a positive and significant impact on investors’ decision-making and risk
tolerance. These relationships are statistically significant at 1% and H1 & H2 are not rejected. The
findings of investors’ personality significantly impact the investment decision-making process and are
influenced by risk tolerance at 1% significant level. Similarly, overconfidence bias findings also supported
the proposed hypotheses of H5 and H6. 

Table 6: Indirect Effects and Decisions Using Structural Model Assessment

Hypothesis Relationships Coeff. S.E t Decisions

stat

H7 Overconfidence Bias>Risk 0.024** 0.011 2.15 Mediation

Tolerance>Investment Decision

H8 Investors’ Personality>Risk 0.024** 0.011 2.17 Mediation

Tolerance>Investment Decision

H9 Financial Literacy>Risk 0.047** 0.018 2.55 Mediation

Tolerance>Investment Decision

Note: *, ** & *** indicates the level of significance at 10%, 5% & 1% respectively
 

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By following the methodology of Hair et al. (2014), while investigating the mediating impact, the
bootstrapping using smart PLS-SEM measure is used to test the indirect impact of risk
tolerance (Preacher and Hayes,2004, 2008). As shown in Table 6, the results of H7 indicate that risk
tolerance positively and significantly mediates the role between overconfidence bias and investment
decision-making at 5% level. Similarly, the risk tolerance significantly mediates the relationships of
investors' personality - investment decisions and financial literacy – investment decisions at 5% level.
These findings do not reject the H8 & H9.

Table: 7 Variance Explain in Latent Constructs

Latent Variable Variance (R2)

Investment Decisions 56.9%

The value of R2 is moderate and reported in Table 7. The findings indicate that all the constructs explicate
56.9% variance in the predicted variable of investment decisions. According to Chin, (2014), if the value of
R2 is 0.19, 0.33 and 0.60 that represents a weaker, moderator and extensive respectively.

Table 8: Total cross-validated redundancies

Variables SSO SSE Q² (=1-SSE/SSO)

Investment Decisions 2000.000 1554.363 0.223

Risk tolerance 2500.000 2184.780 0.126

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By examining the model's predictive relevance (Q2), the blindfolding method is employed through Smart
PLS3. Predictive relevance is used to measure the quality of the model. According to Hair et al., (2014),
the value of Q2 is required to evaluate the parameter estimates. Cross-validated redundancies are used to
assess the quality and power of the research model to forecast the significance of variance dependent on
it. These results are reported in Table 8. Chin (2014) argues that the Q2 value must be greater than zero
and the findings of this study are consistent with the literature.

Table 9: The Results of Size Effect

Variable Names f2 Effect Size

Financial literacy 0.022 small effect

Investors' Personality 0.081 small effect

Overconfidence Bias 0.151 moderate effect

Risk Tolerance 0.020 small effect

Table 9 shows the findings of the size effect that can be used to assess the power of each explanatory
variable in the dependent variable. The value of f2 indicates that other than overconfidence bias, all
variables have a moderate effect on investment decisions, while overconfidence bias has a higher effect
on the investment decision-making process. These findings are consistent with Hameed et al. (2020).

Table 10: Control variables relation with the dependent variable

Control variable Relationship with Dependent variable Coefficient S.E t stat

Age -> Investment Decisions 0.054* 0.029 1.868

Education -> Investment Decisions -0.042 0.031 1.385

Gender -> Investment Decisions 0.037 0.031 1.194

Income -> Investment Decisions -0.025 0.032 0.799

Note: *, ** & *** indicates the level of significance at 10%, 5% & 1% respectively

Table 10 illustrates that the control variable of age has a positive and statistically significant relationship
with investment decisions at the 10% level. Findings indicate that mature investors can produce more

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rational decisions. Education, gender and income of respondents have insignificant associations with the
investment decision-making process.

4. Discussion
This research shows that financial literacy, investors' personality, and overconfidence bias have positive
and significant relationships with the investment decision-making process. Results also indicate that risk
tolerance tailors the relationships when used as mediating factor. The association of independent
variables like financial literacy, investors' personality, and overconfidence bias with investment decisions
has resulted positive and significant with t-values 2.746, 5.155, and 6.706 and risk tolerance 7.414, 3.619,
and 3.190, respectively. Beta values with investment decisions are 0.128, 0.269, and 0.371 and with risk
tolerance are 0.378, 0.195, and 0.195, respectively. The t-values and beta values show that if investors are
more financially literate, have a good personality, and are more confident, and they can produce more
prudent decisions in their investments. Overconfidence bias is the main supporter in investment
decisions, while financial literacy is the main contributor in risk tolerance association. Other than
overconfidence bias, the findings of all other variables are not in line with Arianti (2018). However, the
overconfidence bias finding is consistent with (Aini and Lutfi, 2019). It means that with the increase of
overconfidence bias, investors make better investment decisions. Furthermore, investors' personality has
a positive and significant impact on investment decisions, and the results of the current study are
consistent with the prior study of (Pak and Mahmood, 2015).

5. Conclusion
The primary goal of this study was to investigate the impact of financial literacy, investors' personality,
and overconfidence bias on the investment decision-making process with mediating effect of risk
tolerance. This study employed a random sampling technique to collect the data from industrially
developed cities of Punjab through distributing a questionnaire via a Google form link.

The findings of this study show that financial literacy, investors' personality, and overconfidence bias are
significant determinants in making sound investment decisions by controlling risk factors. Results
indicate that investors who are more literate about financial instruments and their characteristics can
greatly interest investments and savings-related activities. Furthermore, the results indicate that investors'
personality increase the level of investment decisions by controlling risk. Besides, overconfident investors
invest in precarious investments to earn more profit by taking a high risk. On the other hand, control
variables gender, education and income have an insignificant impact on investment decisions.

It is an exciting study for the succeeding researchers to measure the impact of financial literacy, investors’
personality and overconfidence bias during the investment decision-making process. This study helps
investors understand the importance of financial literacy and investors’ personality characteristics during
rational decisions. In addition, this study guides investors on how they can avoid their overconfidence
bias while evaluating different alternatives. This research uses a research questionnaire to collect the

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primary data; researchers may use other techniques to collect data like doing interviews, observations,
and experiments. This study only focused on investors with bank account holders and business
experience investors living in Punjab. Future researches may use the data from different countries to
contrast the findings. Researchers can also add the secondary data of market sentiments and economic
conditions to understand the various investment scenarios better.

Declarations
Statements and Declarations

Competing Interests:

The authors declare that they have no known competing financial interests or personal relationships that
could have appeared to influence the work reported in this paper

Funding Declaration 

There are no funding received by authors.

Biography of Authors

Shahid Hussain is currently doing PhD in Business Administration (Finance) from Department of
Business Administration, Khwaja Fareed University of Engineering and Information Technology (KFUEIT)
Rahim Yar Khan, Punjab, Pakistan. He is also working in School Education Department as an Elementary
School Teacher.

Dr. Abdul Rasheed has done Ph.D. in Business Administration (Finance) from Comsats University,
Islamabad, Pakistan and currently working as Assistant professor and Head of Department, Department
of Business Administration in Khwaja Fareed University of Engineering and Information Technology
(KFUEIT) Rahim Yar Khan, Punjab, Pakistan

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Figures

Figure 1

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