Retail Investor Rationality: The Role of Financial Literacy and Experience Level in Moderating Overconfidence

Abstract

Background: The rise of retail investors in Indonesia has transformed the capital market landscape, yet
the quality of their investment decisions remains a concern. While financial literacy and investment
experience are assumed to promote rationality, there is limited understanding of how psychological
biases, especially overconfidence, interact with these factors in influencing decision making.
Purpose: This research aims to analyze the influence of financial literacy and investment experience on
rational investment decision making among retail investors, with overconfidence tested as a moderating
variable. This study seeks to explore whether overconfidence strengthens or weakens the impact of
cognitive competencies on investor rationality.
Methodology: The study employs a quantitative approach involving 269 active retail investors in the
Indonesian capital market, selected via purposive sampling. Data were collected using structured
questionnaires and analyzed using SPSS version 29. The main techniques included multiple linear
regression to test direct effects and moderated regression analysis (MRA) to test interaction effects.
Financial literacy, investment experience, and overconfidence were measured using validated
instruments adapted from prior studies, and all constructs were tested for validity and reliability before
analysis. Results: The
Finding: The analysis confirms that both financial literacy (? = 0.433, p < 0.05) and investment
experience (? = 0.298, p < 0.05) significantly enhance rational investment decision making. Importantly,
overconfidence significantly moderates these relationships. While it strengthens the effect of investment
experience (? = 0.255, p < 0.05), it weakens the effect of financial literacy (? = -0.194, p < 0.05). These
findings reveal a nuanced interplay between cognition and psychology in financial behavior. The
originality of this study lies in integrating behavioral finance theory with psychological constructs in an
emerging market context. The limitations include the use of self reported data and a cross sectional
design, which may restrict causal interpretation. Nonetheless, the research contributes novel insights into
how behavioral factors shape investment decisions in digitalizing economies.
Limitation: The information respondents obtain in the investment context is often partial or incomplete.
This impacts how they make investment decisions. Bounded rationality theory suggests that individuals
tend to rely on easily accessible or readily available information without conducting a thorough information
search. This limitation can cause the research results to reflect decisions based only on limited
information, thus underrepresenting the decision-making process under ideal conditions.
Originality: The novelty of this research lies in its attempt to examine the factors influencing rational
investment decision-making by individuals. Research directly examining the factors that directly
determine rational investment decision-making by individuals is rare. Mushinada (2020) empirically found
that individual investors often exhibit irrational behavior in investing, including decision-making. Relatedly,
Viryajaya & Handoyo (2022) attempted to examine the factors influencing irrational decisions by individual
investors. The only study that examined the determinants of rational decisions by individual investors is
Lu et al. (2020). However, that study examined the effect of consulting with an investment advisor on
rational investment decision-making by individual investors. The proposed research attempts to examine
21 different factors influencing rational investment decision-making by individual investors, with financial
literacy and experience level as independent variables, and overconfidence as a moderating variable.