JEFMP 03(01/02), 1-16

This study aims to explore a relatively under-explored issue of how individual investors can mitigate overconfidence bias that occurs when investing in stocks. Although investment experience and financial literacy are recognized in the literature as potential mitigators of overconfidence bias, their findings are inconsistent. As a result, the mechanisms that effectively reduce overconfidence bias are unclear. As a novel attempt, this study introduces a moderated mediation model to explore this phenomenon. Based on the literature on cognitive psychology and behavioral finance, it hypothesizes that investors can mitigate their overconfidence bias by engaging in self-reflection of their past investment experiences and enhancing their financial literacy to strengthen this self-reflection process. The data is collected through a self-administered questionnaire distributed to a sample of active individual investors at the Colombo Stock Exchange of Sri Lanka. The mediation and moderated mediation hypotheses were examined using the PROCESS procedure. The results reveal that even though investors’ past investment experiences do not merely reduce their overconfidence bias, self-reflection upon the experiences reduces their overconfidence bias. The results further show that financial literacy alone does not reduce overconfidence bias. Instead, financial literacy moderates the indirect effect of investment experience on overconfidence bias through the mediation of self-reflection. Thus, financial literacy can amplify the positive effects of investment experience on self-reflection and reduce overconfidence bias through enhanced self-reflection. Accordingly, the study concludes that individual investors can mitigate their overconfidence bias by engaging in self-reflection of their investment experiences and enhancing their financial literacy to strengthen their self-reflection ability. The findings of this study contribute to the literature and carry practical implications for individual investors, financial practitioners and policy makers.