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Can Understanding Anchoring Make You a Better Investor?

By The Inspired Investor team

PUBLISHED October 26, 2023 • 3 min read

Let’s say we go shopping together. You and I could look at the same pair of jeans and have very different price expectations. My brain may remember a pair I’d seen years ago and guess $30. But you might have a different assumption and guess $250. If the price is $100, I’ll likely think it’s overpriced and refrain from buying, and you’d probably think $100 is a steal. The crazy part? Neither of our first impressions are based on factual information, quality or personal style.

How could the same price point cause vastly different reactions? Psychologists have a name for this phenomenon: anchoring bias.

What is anchoring bias?

Anchoring bias is a term used in behavioural economics. It’s the tendency to fixate on a specific – but arbitrary – piece of information and make decisions based on it. It’s typically a number and often the first piece of information you received. The brain finds an “anchor” and then measures all subsequent information against it.

This weighty bias comes into play in everything from small-scale shopping choices (those jeans!) to larger purchases (homes, cars, vacations). And investing decisions are certainly not immune.

Anchoring bias can affect how we assign value to anything.

Anchoring in action

A common example of anchoring is real estate. The first price you encounter can change the perception of the homes viewed afterward.

If your realtor tells you that 2-bedroom condos in your city are going for roughly $500,000, you may be overwhelmed by one that’s listed at $600,000 and excited by one that’s priced at $400,000 – all before you weigh the features, benefits and challenges of each. When it comes time to buy, your anchor is then set at $500,000 and you’ll have to work to see past it by gathering relevant facts and information.

Knowing is power

Our financial decisions can be affected by inherent biases and emotional beliefs that might prevent us from taking a beneficial action or push us toward a detrimental one. In investing, decision-making may be skewed by focusing on a specific number—such as the price at which we intend to buy or sell an investment — even when further research may suggest an alternate option.

Anchoring is a cognitive bias based on our first impressions, which can lead to an overreliance on information received early in the decision-making process and deter further research and learning. One way to help avoid this is simply to acknowledge and accept that personal biases are natural. In the case of anchoring, we can start by pausing before making decisions to ask: “Do I need more information before I take this action?”

Just like that visit to the jeans store – avoid relying on your first impression too much, we could step back and ask a few questions, check the price of comparable jeans and look at a few other stores. A little extra knowledge can go a long way.

Mutual Funds are sold by Royal Mutual Funds Inc. (RMFI). There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Please read the Fund Facts/prospectus before investing. Mutual fund securities are not insured by the Canada Deposit Insurance Corporation. For funds other than money market funds, unit values change frequently. For money market funds, there can be no assurances that a fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in a fund will be returned to you. Past performance may not be repeated. RMFI is licensed as a financial services firm in the province of Quebec.

Financial planning services and investment advice are provided by Royal Mutual Funds Inc. (RMFI). RMFI, RBC Global Asset Management Inc., Royal Bank of Canada, Royal Trust Corporation of Canada and The Royal Trust Company are separate corporate entities which are affiliated. RMFI is licensed as a financial services firm in the province of Quebec.

This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.

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