Anchoring is the use of irrelevant information as a reference for evaluating or estimating an unknown value of a good or service.
This behavioural bias can cloud our decision-making. In investing, anchoring can negatively impact our decision making in a variety of ways.
Examples of Anchoring in Investing
Expecting ‘average’ to occur regularly: Often times financial advisors show potential investors an “average expected return” for a particular portfolio or risk objective. Unfortunately if the investor is told that the portfolio may average 6% per year, they are now anchored to that 6% number in their mind. The reality is that markets or asset classes rarely perform near their long-term average in shorter time periods, i.e. in a calendar year. Investors may derive unrealistic expectations from the ‘average anchor’, making it difficult to maintain a level head when investments are volatile.
Basing a sell decision on a purchase price: An investor may have bought stock XYZ for $50 per share years ago. A financial advisor then suggests selling the stock today at $45 per share based on new information that has come to light in the past few years but the investor replies ‘let’s wait until it gets back to $50 per share then we will sell’. The original purchase price of $50 per share has no bearing on the value of the stock today but the investor is anchored to that number.
Basing perception of quality on past experiences: When we are accustomed to a particular system or method we tend to benchmark any new experience to what we’re used to. You may be advised by a friend of a ‘better’ route to and from work – but you’re not familiar with the bottle-necks on the road or with the train schedule for the line suggested. “I’m better off with what I know” you think to yourself.
Suggestions to help combat anchoring
- Expecting ‘average’ to occur regularly: Investors should ask their financial advisor about the potential range of investment outcomes for a given asset allocation, or when investing on your own behalf – do the necessary research on the potential ranges. For example, the yearly returns of the All Ordinaries Accumulation Index (XAOA) had an average return of 13.1% between 1900 and 2018, but it has gained as much as 62.9% in 1975 and lost as much as -40.4% in 2008. In fact, the All Ordinaries Accumulation Index has been within 2% either way of that long-term 13.1% average in a calendar year in only 14 of the last 118 years.
- Basing a sell decision on purchase price: the author has found that financial advisor’s clients respond well to the acronym MAIN – monitor, adjust, inform and navigate. These words really resonate with investors. Inform clients that since the original purchase was made you have been monitoring the company and would like to make adjustments to the position as you navigate the current conditions.
- Basing perception of quality on past experiences: There is no silver bullet to “solving” the mental heuristic of anchoring. Being aware of the biases we have can help us keep an open mind and avoid pitfalls. Things change and evolution of thought is necessary in our daily lives to allow ourselves to take advantage of new and improved processes or opportunities. When we view it simply as “change” or “the unfamiliar” we become frustrated / confused / annoyed. We need to constantly evolve our thinking or opinion.
Anchoring is one of many behavioural heuristics or biases that can inhibit investor returns. Whether you are investing on your own behalf, or consult a financial advisor, we hope the examples and suggestions presented above help in your decision making process.