Anchoring bias is a psychological tendency in behavioral finance where people fixate on the first piece of information they encounter—the “anchor”—when making subsequent financial decisions. This initial data point strongly influences later estimates, often leading to skewed judgments even when better information is available. Recognizing how anchoring bias works can help investors, consumers, and negotiators avoid costly mistakes.
Origins and Scientific Background
Anchoring bias was first identified in the 1970s through experiments by psychologists Amos Tversky and Daniel Kahneman, pioneers in behavioral economics. Their research revealed that even arbitrary numbers can significantly affect people’s estimations. For example, in one study, participants’ guesses about the percentage of African nations in the U.N. were swayed by a random number they spun on a wheel. This demonstrated that initial, irrelevant information could strongly anchor decisions, influencing economic behavior beyond what classical models predicted (Kahneman & Tversky, 1974).
How Anchoring Bias Operates in Finance
Typically, anchoring bias manifests in two phases:
- Anchor Establishment: An initial figure or piece of information is introduced, such as a price, salary offer, or stock value.
- Insufficient Adjustment: When making decisions, people adjust away from the anchor but usually not enough, causing their final judgment to remain biased toward the original number.
For instance, if you’re selling your home and the first valuation you hear is low, you may unconsciously continue to base your price expectations on that figure, even if the market suggests otherwise.
Common Examples of Anchoring in Financial Situations
- Retail Pricing: “Was $200, now $120!” uses the higher original price as an anchor, making the sale price seem more attractive.
- Salary Negotiations: The first salary figure mentioned sets a reference point, influencing the negotiation range.
- Investment Decisions: Investors often anchor to the purchase price of stocks, making it difficult to sell at a lower price even when fundamentals decline.
- Real Estate: Initial asking prices can anchor buyers’ perceptions of property value.
- Budgeting: Using last year’s expenses as a baseline can anchor future budgets, limiting re-evaluation of spending habits.
Who is Affected?
Everyone from everyday consumers and investors to professionals and financial advisors can fall prey to anchoring bias. It’s a universal cognitive bias inherent to human decision-making.
Strategies to Mitigate Anchoring Bias
- Awareness: Recognize when anchoring is influencing your decisions.
- Independent Research: Seek multiple sources and data points before settling on a value.
- Set Your Own Anchors: Establish realistic targets based on thorough analysis.
- Consider Extremes: Evaluate best- and worst-case financial outcomes to widen perspective.
- Seek Outside Opinions: Consult financial advisors or knowledgeable peers for unbiased views.
- Focus on Fundamentals: Especially with investments, prioritize intrinsic value over prior prices or target figures.
Common Misconceptions
- It’s not about stubbornness but subconscious reliance on initial info.
- No one is immune—even experts are affected.
- Anchoring applies to any number or initial impression, not only large figures.
FAQs
Is anchoring bias always detrimental? No, it can sometimes guide beneficial decisions if intentional and well-informed.
How is anchoring different from confirmation bias? Anchoring centers on the first received info, while confirmation bias involves seeking info that supports existing beliefs.
Can financial advisors help? Yes, they offer objective analysis that can counteract anchoring effects.
For a more detailed understanding of behavioral finance concepts including anchoring, visit our Behavioral Finance glossary entry.
References
- Kahneman, D., & Tversky, A. (1974). Judgment under Uncertainty: Heuristics and Biases. Science, 185(4157), 1124-1131. https://www.jstor.org/stable/1738596
- Consumer Financial Protection Bureau. Bias in decision-making: CFPB Bias Overview
- Investopedia. Anchoring: Investopedia Anchoring