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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.
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