Anchoring bias is a common cognitive phenomenon that could affect your day-to-day and long-term financial decisions. The good news is that there are ways you could minimise the effect of bias, including anchoring.
First, what is a financial bias? The term refers to mental shortcuts and errors you might make when processing financial information that may lead to “irrational” decisions that don’t align with your long-term plans. There are many different types of financial bias, so read on to find out more about anchoring bias and how to minimise the effect.
Anchoring bias occurs when you focus or rely too heavily on a single piece of information when making financial decisions. It’s a bias that could lead to you dismissing other relevant data or it could skew your perceptions when you’re assessing a financial opportunity.
By “anchoring” your views to certain data, you could make decisions that aren’t right for you.
Anchoring bias could affect your short- and long-term finances
Anchoring bias could affect your financial decisions in several ways.
When it comes to your day-to-day spending, it might affect how you view the price of items. Let’s say you’re searching for a new TV and you find one you want priced at £1,000. You don’t make the purchase right away, and a few weeks later you see the same TV is now £800.
If you anchored the value of the TV to the first price you’d seen, the new, lower price might seem like an excellent deal. Yet, if you did some further research, you might find it was overpriced at £1,000 and it’s cheaper elsewhere. So, if you acted impulsively and purchased the TV when you saw it was £800 it might not be the bargain you first think it is.
Similarly, anchoring bias could affect long-term financial decisions too.
For instance, investors might purchase stock because they believe it’s a “good” price as they’ve anchored their view of it to a particular piece of information that suggests it should be higher. Alternatively, investors might hold on to assets that are no longer right for them because they believe the value will rise despite market conditions suggesting otherwise.
In short, anchoring bias could mean your investment decisions are based on an attachment to a certain piece of information, which might not reflect reality. It could lead to missed opportunities and poor decisions.
5 practical steps that could help you reduce the effect of anchoring
1. Be aware of the effect of anchoring bias
Often, the first step to reducing the effect of anchoring bias is simply to be aware of the effect it could have. Recognising that you may judge financial opportunities based on a single piece of information could give you pause enough to reconsider your initial thoughts before you act.
2. Assess the credibility of sources
There’s so much information available that it can be overwhelming. So, taking some time to assess how credible a source is could help judge whether it’s information you want to use when making financial decisions.
It’s not just the credibility of the source you may want to weigh up either. For example, reviewing when the information was released could be just as important – basing an investment decision on the price of a stock a year ago could mean you’re overlooking more valuable, recent figures.
3. Carry out further research
In addition to reviewing key pieces of information you already have access to, carrying out further research is often useful.
Let’s say you’re making a large purchase for your home, you’ll often shop around to see which retailer is offering the best deal. Taking the same approach for other financial decisions could also help you make better decisions for you.
4. Focus on your long-term plans
Focusing on your long-term plans or budget could reduce the chance of you acting on impulse because you’ve seen what seems like an excellent opportunity at first glance.
Whether a retailer has cut the price of that TV when compared to your anchor or the latest technology company’s shares are falling, take a step back and ask if it fits into your plans – is this potential opportunity right for you and how would it affect your finances?
5. Work with a financial planner
Sometimes an outside perspective could help you see where financial bias, including anchoring bias, could be clouding your judgement. As a financial planner, we’re here to work with you to create a long-term plan that considers your aspirations. Having a plan that’s been tailored to you could help you reduce the influence of bias and make better financial decisions for you.
Please contact us to talk to one of our team or arrange a meeting.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
