What is anchoring?

It is common for people to place a disproportionate amount of weight on the first piece of information they are given regarding an event, subject, or choice. This is referred to as anchoring.

Are you a person who enjoys bargains and gets thrilled when you get a good deal? This is only one instance of how your decision-making process might be influenced by the information you discover first.

According to the field of behavioural insights, this effect represents a particular kind of behavioural bias called the anchoring effect or anchoring. The anchor is the information that appears first. We use anchors in a lot of our decisions, from negotiating salaries to taking advantage of shopping discounts.

 

What does anchoring look like?

Consider the following scenario: you are in a shopping mall and you see a $300 pair of shoes. You walk a few stores down, scoffing at the price, and see an almost identical pair of shoes that retail for $150. You feel as though you are saving money when you contrast the $150 price with the $300 cost of the original pair (the anchor). Consequently, you choose to purchase the shoes. Although it seems like you saved money, in actuality, you still paid $150 for a pair of shoes. Thus, the anchoring effect.

This example shows how our judgment and decisions are impacted once the anchor is placed. It may surprise you to learn that an anchor can still have an impact on your choices even if it has no bearing on the current circumstance. According to a study, people’s perceptions of the number of African nations that are UN members are significantly impacted by the number displayed when a roulette wheel is spun, even if the number is entirely random.

Other examples such as negotiating salaries, people who ask for unrealistically high salaries during negotiations are more likely to receive a higher offer from their employer. This is known as a high anchor. Restaurants use menus for high-price anchors, listing their higher-priced dishes first on the menu to make lower-priced dishes appear cheaper.

 

How does anchoring affect your financial decisions?

Your financial decisions might be impacted by anchoring in several ways. Here are some common examples:

 

• Spending

Even though items are at a reduced price, people frequently buy them because they are at an excellent price. Even though they are still spending, they feel as though they are saving money because of the discount from the higher price (the anchor). Discounts may encourage consumers to spend more money in certain situations.

• Investing

When determining a stock or a fund’s fair price, most individuals use the present price as an anchor. Furthermore, even in cases where selling a stock or fund makes sense, a lot of people find it difficult to sell the shares they own when the price is less than what they paid for it. The loss aversion combined with the initial price which serves as an anchor causes needless stress.

 

When working with a fiduciary financial advisor in Hong Kong, behavioural finance plays a big role for the advisor. Most investors know they should avoid emotional investing decisions but turning intentions into reality is another matter. This is where Private Capital can help provide support, guidance and coaching when a long-term view and staying on course is needed for the investor.

 

How can you protect yourself from the downside of anchoring?

Anchoring can be one of the most difficult behavioural biases to shake. Despite that, here are a few strategies you can use to limit its influence on your decisions:

 

• Diversify your portfolio

Avoid anchoring bias by diversifying your investments across different asset classes, industries, and regions. Buying a globally diverse, low-cost index tracker fund can help avoid overthinking what the best price is. How can you research what the best price is for all stocks included in a globally diverse fund? You can’t trust the price is right, in the present.

• Dollar-Cost Averaging

Automated contributions monthly into your investment account ensure consistent and disciplined investing. This can prevent investors from being swayed by short-term market movements or anchoring to specific price points. This can lead to focusing on the long-term average cost, rather than trying to time the market.

• Staying committed to your strategy

Stick to your investment plan. Whether it is a dollar cost averaging approach with or without a financial advisor, staying consistent can help smooth out market volatility. Avoid short-term noise in today’s media as this can influence your investment decision.

 

Financial advisors ensure our client’s plan gets implemented. To learn more about our investment strategy, learn more about it on our website here, or meet one of our financial advisors in our office, located in Central Hong Kong.