How Anchoring Clouds Your Financial Judgment

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Have you ever bought something and later realized you overpaid? Or make a decision based on the first bit of information you received? You might have fallen victim to Anchoring Bias.

Anchoring bias occurs when we rely too heavily on the first piece of information we receive – referred to as the anchor - when making a decision. Once we have an anchor, we subconsciously adjust our decisions around the anchor, even when it’s far from reality. This shortcut helps our brains avoid information overload but can steer us wrong, especially in financial situations.

An example of anchoring bias is in pricing strategy. Let’s say you’re in a clothing store with a $20 budget. You spot two similar shirts—one priced at $100 and the other at $50. The $100 shirt sets an anchor, making the $50 shirt seem like a bargain, even though it’s still way above your budget. By placing higher-priced products beside moderately priced ones, marketers exploit the anchoring effect to influence your perception of value. By anchoring your perception of value at a higher price point, the lower-priced option appears more affordable, increasing the likelihood of purchase.

How Anchoring Bias Affects Your Financial Decisions:

Purchasing Decisions. When making a buying decision, the initial price you encounter can serve as an anchor and may influence how much you’re willing to pay. For instance, if you see an item originally priced very high but then offered at a “discounted” price, you might perceive the discounted price as a good deal, even if it’s still higher than the item’s true value. Companies and marketers sometimes use this strategy to promote their products. This is particularly common with e-commerce websites - raising prices before a sale and lowering them to the usual price afterward to make it seem like a huge discount.

Investment Decisions. Anchoring bias shows up in investments too, especially in the stock market. If you anchor on a recent high price for a stock, you might hesitate to sell it even if its current value has dropped significantly and the probability of a price recovery is low. Let’s say you bought a stock at $150, and its value drops to $100. You might hesitate to sell because you're anchored to that $150 purchase price, hoping it will bounce back—even if market trends suggest otherwise. Similarly, if you hear that a stock was recently at $200, you might think $150 is a bargain when it’s not necessarily a smart buy based on its fundamentals. When buying or selling a property in real estate transactions, the initial listing price can serve as an anchor that influences your perception of the property’s value. This can lead to overpaying for the property.

Salary Negotiations. Anchoring happens in salary discussions as well. For instance, if your current salary is $50,000, and you’re offered $55,000 at a new job, you might anchor on the initial offer. However, if you research your market value and find out that people in similar roles are earning $65,000, you’ll see that $55,000 isn’t as attractive. Likewise, if an employer starts negotiations with a lower salary figure, that number can act as an anchor for both parties unless you push back and set new expectations.

Loan Decisions. When shopping for loans, the first interest rate you see can anchor your perception of what's a "good" rate. If you're offered a 10% rate initially, and then see an 8% rate, it may feel like a win—even though better rates might be available elsewhere. Anchoring can prevent you from shopping around and finding the best deal.

Overcoming Anchoring Bias

While it’s easy to fall into the anchoring trap, you can use these strategies to avoid it:

• Be aware of this bias and how it can affect your decisions.

• Do your research. Gather as much information as possible from multiple sources before making a purchase, investment, or financial decision.

• Set your anchors ahead of receiving any information. For example, if you're shopping for a shirt, decide that your limit is $50 before you even step into the store. This way, you're less influenced by inflated prices.

• To set your anchor, you can use the number of hours you will have to work to afford the item based on your hourly rate or the proportion of income you are willing to spend on that item.

• Seek independent advice from experts for major purchases, investments, or loans. This helps counteract any bias from a single source of information.

• Take your time to deliberate on big financial decisions and avoid making impulsive choices.

• Negotiate wisely. In (salary) negotiations, try to set the anchor by stating your numbers first before others can anchor the discussion. If an offer has already been made, defuse their anchor by pointing out that it’s far from your expectations, then counter with your desired figure.

• Practice critical thinking by seeking opposing views and being open to different perspectives.

In conclusion…

Anchoring bias plays a big role in our financial decisions, from shopping to investments and salary negotiations. By being aware of this cognitive bias and using strategies to counter it, you can make more informed, rational choices.

As a consumer, next time you're adjusting your expectations based on a price, ask yourself: Am I anchored to a number that doesn't reflect true value?

You should also be aware that you can use anchoring to your advantage. As a business owner or marketer, you can use anchoring to your advantage by setting your pricing strategy around these principles, creating perceived value for your products.

Feel free to send in your questions; you may be influencing the next newsletter!

Act Now:

• Begin to pay close attention to price anchors when making purchases

Reflect on This:

• Do you usually have a price target in mind when making major purchases?

Till next week, I am rooting for you, money-ly!

Dee

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Disclaimer: This does not constitute financial advice. Please conduct your research or consult your financial advisor for important financial advice.