INVESTMENT DECISION BEHAVIOR: DOES INVESTORS RATIONAL OR IRRATIONAL?

Nik Maheran Nik Muhammad1, Nurazleena Ismail2

1,

Faculty of Business Management, MARA University of Technology, Kelantan, Malaysia nmaheran@kelantan.uitm.edu.my 2, Faculty of Business Management, MARA University of Technology, Kelantan, Malaysia azleena@kelantan.uitm.edu.my

ABSTRACT: Malaysian capital market offers an array of investment products in a form of shares, loan stocks, bonds, warrants, and unit trusts. The type of products chosen by an investor to commit his capital depends largely on his financial goals, time frame, and amount of capital available. Different people invest with different strategies or even no-strategies. However, previous studies found that most individual investors who play the stock market often ask for hot tips that will enrich them overnight. Too often investors buy stocks on a whim or on the recommendation of a stranger when they should buy stocks that are showing fundamental strength and consistence with their investment objectives. Therefore, the main objective of this research is to study factors that influence investors investment decision making. Do they rational or irrational in their decision making behavior. The population for the study consists of individual investor who trade share at Bursa Malaysia. 147 questionnaires were distributed and usable. The results from correlation analysis indicate positive and significant correlations among the independent and the dependent variables. However, multiple regression analysis shows significant relationships only exist for economy and frame of references indicating that Malaysian investors rely both on fundamental analysis as well as following others opinion (herding). In other words, they are partially rational in their decision making.

Key words: Investment decision-making, risk tolerant, herding behavior

INTRODUCTION Most ordinary people who play the stock market often ask for hot tips that will enrich them overnight. Too often investors buy a stock on a whim or on the recommendation of a stranger when they should buy stocks that are consistence with the investment objectives. According to Frieder (2004) survey, respondents saidfor me, investing is playing with stock marketsit gives me a kick. Apart from its value as a piece of anecdotic evidence on investor behavior, it also serves to illustrate that for many investors, investing constitutes more than simply weighting the risk and returns of various investment assets. Being aware of the many considerations and needs beyond risk and return that influence investors behavior, it is surprising that finance journals are mostly confined to the utilitarian benefits of low risk and high expected returns. According to Olsen (1998), most people consider themselves to be risk-avoiders rather than risktakers. People will make decisions in which they are willing to accept a certain small return rather than a larger, but uncertain profit, from their financial decisions. The function of a measure of risk tolerance should be to differentiate people on the basis of the level of risk that they are willing to accept. Such a test can also be used to measure the risk tolerance of the same person over time. That is, attitudes like risk tolerance are likely to change over time as people experience

the positive and negative outcomes of their previous investment decisions, changes with age to their family or work lives, and changes in the performance of national and lobar markets. However, social psychological research reveals that most changes in attitudes take one time to emerge (Gurtler and Hartman, 2007). The investment environment in Malaysia has changed considerably overtime and opportunities for individual investors to become involved in have increased considerably, particularly as a result of encouragement from institutional changes. The overall purpose of this research is to gain knowledge about key factors that influence investment decision style focusing on whether the investors are rational of irrational in making their decisions. In this paper, we have focused on the behavior of individual investors when buying various type of investment. In particular, we have conducted a behavioral finance analysis.

HYPOTHESES DEVELOPMENT Theory of Behaviorism The theoretical model employed in this research is based on the theory of behaviorism. It is an extension of Prospect theory or also known as Risk aversion theory introduced by Khneman and Tvensky (1979). This theory asserts that, when it comes to investing, people may not be as rational as they think. Behaviorists argue that investors often behave irrationally when making investment decisions thereby incorrectly pricing securities. They relate investors decision making behavior to gambler's fallacy, anchoring, mental accounting, overconfidence, overreaction (i.e emotion/intuition) and herding behavior (e.g Banerjee (1992) and Bikhchandani, Hirshleifer and Welch (1992)). Therefore it is hypothesize that: H1: Investment Decision making style of an investor is positively related to their emotion or intuition. H2: Investment Decision making style of an investor is positively related to their frame of references of and investors (herding behavior) However, many economists argue that investors behave rationally when buying stocks. They are presumed to use all available information to form rational expectation about the future in determining the value of companies and the general health of the economy. Consequently, stock prices should accurately reflect fundamental values and will only move up and down when the unexpected positive or negative news, respectively. Thus, economists have concluded financial markets are stable and efficient, stock prices follow a random walk and the overall economy tends toward general equilibrium. Therefore, it is hypothesized that: H3: Investment Decision making style of an investor is positively related to their ability to analyze environmental factors H4: : Investment Decision making style of an investor is positively related to their ability to analyze economic factors H5: : Investment Decision making style of an investor is positively related to their ability to analyze financial factors

RESEARCH MODEL Based on the literature reviewed conducted for this research, it was found that study on investors behavior was exhaustively done (e.g Al-Hogail (2004), Olsen (1998), Pinello (2004), Barberis and Thaler (2002)). Contradict opinion was found in terms of rational level of the investors. Many researchers categorized investors who make their decision based on information of the environment and fundamentals of the company as rational investor. Irrational investors are those who involve in herding behavior, speculation and rely their investment decision on frame of references. Below is the theoretical framework of this research:

Figure 1: Theoretical framework of Investors Behavioral Decision

IRRATIONAL BEHAVIOR Emotion/intuition Frame of references

INVESTMENT DECISION

RATIONAL BEHAVIOR Environmental/external analysis Economic analysis Financial analysis

METHODOLOGY Sample and procedure Data for this study was collected through structured questionnaires. The questionnaires were distributed to the investors traded their share in stock broking companies around Klang Valey. A total of 147 responses were obtained from 200 questionnaires sent.

Variables and measurement The instruments were adapted from various literatures and were modified for the adaptation to the investors behavior context. The dependent variable, Investors decision making was measured using five items. Responses were measured using five-point Likert type scale anchored by

strongly disagree (1) to strongly agree (5). Meanwhile for the independent variable items with five-point Likert type scale was used to measure, with scale ranging from very unlikely (1) to very likely (5).

ANALYSIS AND RESULT The respondents comprised mainly of male, which is 71.4% and females 42%. In terms of age, the majority of the respondents are between the age of 30 to 39 years (49%) with , 21.1% having SPM, 15.6% Diploma/STPM level, 53.7% having Bachelor Degree, and 6.1% had their Master degree. 2.0% PhD and the rest (1.4%) of the respondents had other types of academic qualification. In term of the occupation, 16.3% of the respondents are working in government sector, 29.3% in private sector and mostly respondents are self-employment (54.4%). In terms of income, most were earning RM 4,000 to 6,000 per month with 39 percent. Descriptive analysis for investment profile shows that investors choose investment vehicles in the category of low risk tolerant with a mean of 4.47 for unit trust/investment link followed by property investment (4.34), bond (3.95) and stock market (3.55). This indicates that the investors understudied are having risk averse attitude. Table 1: Investment profile bond 3.95 .594 stock 3.55 1.118 property 4.34 .872 Unit trust/inv. link Money market 4.47 3.97 .805 1.020

Mean Std. Deviation

Based on the descriptive analysis of investment decision making behavior, it shows that economic factors is the most influential factors in determining their investment buying behavior followed by financial and frame of references. However, in terms of relying on emotions (i.e gut-feeling, over-reaction) most respondents were rating that they are unlikely of doing so. Table2: Decision profile Variables Rational Behavior Environment Financial Economy Irrational Behavior Emotion Frame of references Goodness of measure Decision N=147 Mean 3.00 3.69 3.80 2.95 3.1850 .847 .942 .628 1.057 .76143 Std. Deviation

Factor analysis is a data reduction technique and also used to determine whether items are tapping into the same construct. During factor analysis, factors with eigenvalue of more than one would be retained for further analysis (Hair et al., 2006). To reduce the problem of cross loading, if the differences of loadings of any item across factors were less than 0.50 than the items will be deleted (Snell and Dean, 1992). Next, reliability testing was applied to determine the degree to which measures are free from random errors. Reliability analysis was applied to identify how well the items grouped are positively correlated to one another. Cronbachs value of 0.60 and above is considered to be reliable (Nunnally and Bernstein, 1994) as it indicates the items are homogenous and measuring the same construct. The result of the factor and reliability analysis is presented in Table 3 to 5. Factor analysis was conducted for items of investment decision, rational behavior and irrational behavior. Rational Behavior Table 3 presents the results of varimax factor rotation of all variables for investors rational behavior measuring via fundamental analysis done. From the 18 items, 10 items loaded on three factors. Five items, which form external/environmental analysis, was loaded in factor 1 with a variance of 39.5 percent, two items from financial analysis loaded on factor 2 with 31.28 percent and three items from economic analysis loaded on factor 3 with a variance of 19.2 percent. The total variance achieved is 80.14 percent. Furthermore, all the Cronbachs alpha values were between 0.72 to 0.99 Table 3: Factor analysis and reliability test result F1 .942 .938 .931 .828 .793 Factor Loading F2 F3 F4 F5

Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12 Q13 Q14 Q15 Q16 Q17 Q18

Nikkei Hang Seng Dow Jones M'sia For invt policy M'sia political situation Investment objective Company fin. Perform. Current market price Historical market price World economy Speculation Herding Confidence Television Fund advertisement Magazines Friends influence Top ten stock Reliability Cronbach Alpha

.961 .956 .830 .763 .744 .949 .934 .666 .910 .898 .719 .629 .584 .954 .806

.933

.994

.719

Eigenvalues Percentage of Common variance Cummulative % Irrational Behavior

3.956 39.556 39.556

2.138 21.381 60.398

1.920 19.203 80.141

2.216 73.874 73.874

2.888 57.75 57.75

In conceptualizing the irrational behavior, table 3 shows that three items form emotion or intuition behavior loaded in factor 4 with a variance of 73.87 percent, five items determine frame of references loaded on factor 5 with 57.75 percent. Cronbachs alfa values for emotions or intuition behavior and frame of references were 0.95 and 0.81 respectively.

Investment Decision In identifying investment decision of the investors, table 4 shows that five items was loaded unidimensionally with a variance of 76.81 percent. Cronbachs Alfa values were 0.92. Overall it shows that statistically, the items understudied is valid and measure what its suppose to measure and having high consistencies with each other with acceptable Cronbach Alpha of more than 0.8. Table 4: Factor analysis and reliability test result on Investors decision Investors decision style Q1: investment expected return Q2: Investment holding period Q3: Investment objectives Q4: Investors risk tolerance Q5: Investors reaction towards loses Cronbach Alpha for nature of decision Eigenvalues %age of Common variance Cumulative % Factor 1 .921 .910 .866 .849 .833 .924 3.841 76.815 76.815

Test of Relationship Correlation analysis indicates the strength of bivariate relationships among the independent and dependent variable under studied. This therefore indicates an early indication of possible Frame of interrelationships in multiple regression. The correlations between the independent variables also Std. Decision Environ referenc can be used to identify reasons for insignificance of one independent over another when Mean Deviation making ment Financial Economy Emotion es explaining the variations in the dependent variables for multiple regressions analysis. Decision 3.05 .868 1.000 making Table 5 Environment .847 .061 1.000 Correlation analysis 3.00 3.69 .942 .469** .072 1.000 Financial Economy 3.80 .628 .743** -.021 .390** 1.000 Emotion 2.95 1.057 .017 -.080 .291** .143 1.000 1.000 Frame of 3.1850 .76143 .669** .054 .603** .567** -.030 6 references

** Correlation is significant at the 0.01 level (2-tailed)

The results of correlation analysis are tabulated in Table 4 above. The table indicates high To evaluate the behaviors that influence investors decision-making style, Stepwise Regression Analysis was applied. Regression analysis was used to test the hypotheses. The result of the Stepwise Multiple Regression Model is reported in table 6 below.

Table 6 Model summary and standardize Beta Coefficient of multiple regression analysis F value Model Summary Environment Financial Economy Emotion Frame of references 52.866*** R square .652 Adjusted R square .640 R square change .652 F change 52.866*** .043 .095 .550*** -.077 .295*** Beta

***significant at the 0.01 level, ** significant at the 0.05 level, * significant at the 0.1 level The result of multiple regression analysis shows that the relationships exist between the independent variables (rational/irrational) with dependent variables (investment decision making). The model was significant ( p>0.01) with F-value of 52.87. The coefficient of determination (R2) is 0.652, which indicate that 65.2 percent of the variations in investment decision-making were explained by the independent variables (environment, financial and economic analyses as well as emotion and frame or references). The multiple regression analysis in this stage also indicates that the tested variables are significant at p, 0.01. The b-values (standardized coefficients) for each of the variables are as follows: Environment ( b=.043), Financial (b=0.95) economy (b=.550) Emotion (b=-.077) and Frame of References (b=.295) indicating that only economy and frame of references are positively related to investment decision making. Therefore, it is concluded that only H3 (rational behavior in terms of analyzing the economy is positively related to investment decision making style) and H5 (frame of references is positively related to investment decision making style) were supported.

DISCUSSION As mentioned, this study intends to investigate the relationship between investment decisionmaking of an investors and their rationality in investing. Rational or irrational behavior was conceptualized based on whether they analyze their investment before deciding to invest or relying on their emotions and frame of references respectively. The direct positive relationship of economic analysis and frame of references was found significant to investment decision making of Malaysian decision maker. This indicates that the investors neither were relying on their emotions or intuition in making their investment nor exhaustively analyzes their investment before making their decision. Therefore, previous study conducted by researchers like; Elsayed & Martin (1980), Katz (1998), Young and ONeill, (1992) was not in line with the current study as in their study, they found that investors are irrational in their decision making. In the current study however, we found that investors do analyzed their investment fundamentally but just on the economic condition but not on other aspect such as company financial analysis or external information such as regulation and world event. At the same time, they are also relying on the influence of friends, relative and remisiers in their decision making. Therefore, we could conclude that Malaysian investors of partially rational in their decision making. This argument is consistent with the study done by Marota (2008). According to him, investors do not make decisions in a vacuum. They may make better decisions by trying to understand the behavioral factors that can influence their judgment for example herd mentality (i.e. following the behavior of others). Herd Mentality on investment decisions has the potential to provide investors with many psychological benefits. Herding reduces the time needed to properly analyze an investment decision. It can also help reduce feelings of regret if the investment choice was a bad one. Investors can find comfort knowing that they were not alone in their decision. Herding can also be a powerful tool in influencing market movements. It is supported by the argument of Hoffmann and Wander (2003) who identified that, the needs, social interactions and (social) networks effect are keys to understanding micro level investor behavior and macro level stock market dynamics In addition, the findings of the current study also found that Malaysian investors only relying and analyzing economic condition in making their investment decision. Companys performance, government policy or political conditions locally and internationally was not of their interest. This findings is consistent with the assumption of Friedman (1988), that most of the investors consider economic condition and price movement as the most significant contribution to their gain and losses in investing. Others, such as companys performance, political condition and government policy is considering giving major effect only on the long run. This empirical study has several limitations. Firstly, the scope of investigation was done only at Klang Valey. Therefore, in terms of external validity in generalizing the behavior for all Malaysian is still questionable. Secondly, the findings of this study depend largely on the respondents honesty and integrity. However, if the respondents answers were bias towards more socially desirable answers, the findings will also indicate biasness. It is known that

individuals would agree more on socially desirable answers and disagree more towards socially undesirable answers rather than fully and truly express their feelings and the opinions. CONCLUSION Based on the research findings, it indicate that economic condition and frame of references influence investors decision-making behavior. Therefore, the results from this study have shed some light on the constructs of the behaviorism model. As the current study found that investors are partially rational in making their investment decision, the insights provided by this study could be used by investors, organization and the government as a foundation to formulate strategies to control and monitor the stock market behavior and at the same time having more professionals advisor in advising small investors in making their investment decision.

REFERANCES

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