Anchoring

ANCHORINGanchor

The issue: People tend to estimate values by adjusting from an initial starting point. The initial value may come from a formula or it may simply be provided by a reasonably credible source. Once established, it’s almost impossible for us to disregard the initial number and subsequent adjustments are typically insufficient (Slovic & Lichtenstein, 1971).

This is such a significant effect that different starting points will yield dramatically different estimates. (Kahneman, 2011) Also, we tend to rely too heavily, or anchor our decisions, on this one piece of information, which is why a sale price is so appealing, once we are told what the regular price is.

This bias becomes a problem when investors tie decisions to continue to hold a security to their initial purchase price. When investors become anchored to the purchase price of a security, they often fall into the trap of disregarding other information that would otherwise prompt selling the investment, wanting to avoid the pain of recognizing the loss.

The Solution: When considering whether to hold an investment for the future, remember that the purchase price doesn’t give you any information about future prospects of the investment. Wise investors will not let this number become any part of their investment decisions, focusing on relevant outlook and suitability instead.

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