Impact of Investor Heuristics on Risk-Return Trade-off: A Behavioural Finance Perspective

Abstract

The traditional risk-return paradigm, fundamental to financial theory, presumes rational investors who want to maximize profits while mitigating risk. Nonetheless, actual investment actions frequently deviate from this reasonable model due to cognitive biases and heuristics. This study analyzes how prevalent investor heuristics, including representativeness, availability, and anchoring, influence perceptions of risk and return, thus impacting portfolio decisions. This research used a quantitative, cross-sectional approach with a sample of 400 retail investors, including descriptive statistics, correlation analysis, and multiple linear regressions to examine these biases. The findings indicate that, among the heuristics examined, anchoring has a statistically significant negative correlation with perceived returns, but representativeness and availability display no considerable effect. The findings highlight the crucial influence of behavioral tendencies on financial decisions, questioning standard finance assumptions and promoting the incorporation of psychological insights into investment theory and practice.