What is Anchoring?
Anchoring is a psychological shortcut where the first piece of information you hear becomes the center of gravity for your decision. That's the anchoring bias in a nutshell. Behavioral economics describes how irrelevant data can disproportionately influence financial choices. This "anchor" point, even if arbitrary, becomes a reference for our judgment.
Anchoring is particularly tricky when valuing something subjective, like a house or a stock. People can latch onto seemingly relevant information, like a starting price, and build their entire financial decision around it. This is where things get messy for investors – anchoring can lead to costly mistakes by overlooking valuable information.
How Anchoring Works
Behavioral finance exposes a decision-making quirk called anchoring bias. It occurs when investors cling too tightly to an initial piece of information, like a stock's purchase price, turning it into a psychological benchmark. This "anchor" holds undue weight, even if irrelevant to the stock's true value.
This bias can lead investors to hold onto losing stocks. Anchored to the original purchase price, they believe the stock will eventually rebound, even if fundamentals suggest otherwise. This creates unnecessary risk as they hold onto the investment, hoping for a return to a potentially inflated price.
While some investors might try to adjust their thinking based on new information, the initial anchor often leaves its mark. Their final decisions still show a subconscious bias towards that first, potentially misleading data point.
Example of Anchoring
You're in the market for a new phone. You've been eyeing a particular model for a while, and you've seen it advertised for around ₹25,000. When you finally go to a store, the salesperson mentions there's a slight discount, bringing the price down to ₹22,000.
Because you had the ₹25,000 price in mind as an anchor, the ₹22,000 price might seem like a very good deal, even if you haven't compared prices at other stores or considered alternative models. You might be less likely to shop around for a better price or consider other features entirely because of the initial ₹25,000 anchor point.
This is anchoring bias at play. The initial, possibly non-discounted price has a strong influence on your perception of the phone's actual value.