What Is Anchoring Bias In Investing?

Anchoring bias is a cognitive effect that makes the first piece of information you encounter seem more relevant than the data you see later. Essentially, that first piece of data anchors your perception. As you encounter more research, your mind compares it to the anchor point.

Once you’re aware of anchoring bias, you can probably spot it in your daily life. Luckily, you can take steps to minimize the influence of anchoring bias on your investments. Resisting the pull of this bias might, however, require changing some of your thought patterns and behaviors.

Anchoring bias in investing happens when this cognitive effect interferes with making rational decisions about your investments.

Examples of Anchoring Bias

It’s often easier to understand cognitive biases when you see them in real-world situations.

Salary Negotiations

A lot of people use anchoring when negotiating for their job compensation packages. Let’s say you enter the discussion and the hiring manager says the position pays $65,000.

That person has already set an expectation that restricts how much more money the average person will ask for. You might respond that you need $70,000. An extra $5,000 doesn’t seem outrageous.

Would you suggest $100,000? Probably not. It seems outrageous to stray so far from the original number, so you end up letting the original number influence your salary request.

Vehicle Prices

Anchoring bias also happens frequently when people buy vehicles and other high-priced items.

Maybe you do some research and see that the vehicle you want to buy usually sells for $70,000. When you visit the dealership later that day, they offer to sell the car for $68,000. That sounds like a great deal because you expected to pay $70,000. Perhaps you agree to buy the vehicle on the spot.

What you don’t know is that a different dealership is selling the vehicle for $65,000. Anchoring bias made you so excited to save $2,000 that you end up paying $3,000 more than necessary.

How Anchoring Bias Could Hurt Your Investment Strategy

Anchoring bias in investing can encourage you to make rash decisions that you mistakenly believe are good deals. If you see that a stock trades at $100 today, you might jump at the chance to buy shares at $90 each.

Without further research, you don’t know if you’re getting a good deal. What if the stock traded for $70 last month? Suddenly, $90 sounds very high!

Here are some other ways anchoring bias could influence your investment strategy:

You Believe the Opinion You Hear First

Most investors rely on the opinions of professional analysts. After all, these pros have a lot of experience and they spend their days researching investment options.

Unfortunately, you might give the first opinion you encounter more weight than the opinions you see later. Perhaps the first analyst says you should buy a stock if it falls below $50. You don’t have much context at this point, so that sounds reasonable to you. Later, you see analysts saying you should buy at different prices. Some sound too high, while others sound too low.

Why do the other recommendations seem incorrect? Because the first opinion you read created an anchor price that has influenced your perception.

A Stock’s Past Performance Convinces You to Buy

You know that Company A has years of growth, so you want to buy some shares and benefit from its continued growth.

Maybe investing in Company A is a smart decision. Choosing to invest because of past performance, though, is a kind of anchoring bias. It’s important to do more research and look at recent financial disclosures to determine whether the growth will continue. Until you do that additional research, there’s a good chance you’re falling victim to anchoring bias.

Keep in mind that anchoring bias may very well also encourage you to avoid a growing company that has an unsuccessful past. In reality, you can’t base future performance on old numbers. If you do, you could miss chances to add valuable companies to your portfolio.

How You Can Avoid Anchoring Bias in Investing

Anchoring bias tricks investors into making bad decisions that seem reasonable. What can you do to avoid the pitfalls of anchoring bias? Start with the following strategies. It might take some time to notice when anchoring bias is influencing your investing, but you can develop skills that make you a smarter investor!

Get Information From Diverse Sources

Don’t let one analyst drive your decisions. Find diverse sources you trust to give you objective information and informed insights.

Importantly, you need to remind yourself that an opinion doesn’t have more value just because you read it first. Spend time learning from several professionals. Then, sit with the information for a while — it might take several days or weeks. The effect of anchoring bias should wane over time, making it easier for you to view opinions objectively.

Look for Research That Challenges Your Position

Do you feel certain that you know what investment decision to make? That’s not necessarily bad. You should invest in companies you’ve researched and believe in.

Then again, you could feel overly confident because the anchoring effect has skewed your perspective.

Look for research that challenges your position, and take those opinions seriously. If you start feeling less certain, you might want to wait a while longer before you invest your money.

Give Yourself Time Before Making Important Decisions

Time is one of the most effective antidotes to anchoring bias. With enough time, you will most likely forget which number or opinion you saw first. Ideally, the research starts to hold equal weight so you can make an informed decision without cognitive bias.

It takes some people more time than others to escape the effects of anchoring bias. In this instance, having a terrific memory could get in the way of making smart investment choices. Do your best to wait until you don’t feel emotional about the decision. By then, you’re probably making rational decisions.

Any cognitive bias could interfere with successful investing. Build a diversified investment portfolio, and don’t make sudden changes to your portfolio. Yes, there’s always a risk when you invest, but these strategies will help protect you from issues like anchoring bias.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.