Are you somebody who loves discounts, and get excited when you see a low price? This is just one example where the first piece of information you encounter can influence your decision making.
The field of behavioural insights tells us that this effect is a type of behavioural bias known as the anchoring effect, also known as anchoring. The first piece of information you see is known as the anchor. Anchors are present in many decisions we make, from grocery discounts to salary negotiations. Find out more about anchoring and its potential impact on your financial decisions.
On this page you’ll find
- What is anchoring?
- What does anchoring look like?
- How does anchoring affect your financial decisions?
- How can you protect yourself from the downside of anchoring?
What is anchoring?
Anchoring is the tendency for people to rely too heavily on the first piece of information they are offered about a situation, topic, or decision.
For example, suppose you are browsing a clothing store and come across a pair of jeans priced at $300. You scoff at the price, walk a few stores down, and notice an almost identical pair of jeans priced at $150. As you compare the $150 price to the $300 price of the original pair (the anchor), you feel like you are saving money. As a result, you decide to buy the jeans. The reality is that you still spent $150 on a pair of jeans, even though it feels like you saved money. This is the anchoring effect.
This example demonstrates that once the anchor is set, it affects our judgement and decisions. Surprisingly, an anchor can still influence your decisions even if it is completely irrelevant to the situation at hand. One study found that peoples’ estimate of how many African countries are members of the United Nations is greatly influenced by the number they see when a roulette wheel is spun – even though the roulette number is random and completely irrelevant.[1]
What does anchoring look like?
Anchoring is one of the most widespread behavioural biases, and often influences people in ways they are completely unaware of. Here are a few examples:
- Discounts – People are more likely to purchase something if it is discounted from a higher price. This applies to groceries, subscriptions, clothes, and many other products. People anchor to the crossed out higher price, which makes them feel like they are saving money with the discounted price — even though the product could be even cheaper at a different store.
- Salary negotiations – Research shows that people who ask for an ambitiously high salary during negotiations are more likely to receive a higher offer from their employer. This is called setting a high anchor, and it is one of the most common techniques used in negotiations.
- Restaurant menus – Some restaurants list their higher priced dishes first on their menu. This sets a high price anchor and makes the lower priced dishes that follow appear cheaper. This could lead people to buy the lower priced dishes even though they may still be expensive when compared to the same dishes at other nearby restaurants.
The anchoring effect is extremely widespread, and it also influences your decisions about money.
Our individual behaviours are prone to bias. That can make financial decisions challenging. Try our behavioural bias checker to understand how biases might be affecting your financial decision making.
How does anchoring affect your financial decisions?
Anchoring can affect your financial decisions in several ways. There are a few common areas where you will notice it, including:
- Spending – People often purchase things because it’s a good deal — even though discounted products still require them to spend money. The discount from the higher price (the anchor) makes them feel like they are saving money, even though they’re still spending. In some cases, discounts can cause people to spend more money, not less.
- Investing – When asked to evaluate the fair price of a stock, most people will take the current price (the anchor) and make small adjustments up or down. Additionally, many people are unwilling to sell their stock if the price is lower than what they bought it for, even if it is a smart decision to sell. This is caused by both loss aversion and the original price acting as an anchor.
- Budgeting – Many budgeting tools come with default spending limits (i.e., gas, rent, etc.). By serving as an anchor, these default amounts influence the limits people will set for themselves. They adjust each limit up or down from its default amount, rather than setting a more accurate limit to reflect their real spending habits.
Anchoring plays a fundamental role in many of our financial decisions. In many cases, the presence of an anchor can lead us to make decisions that are not in our best interest.
How can you protect yourself from the downside of anchoring?
Anchoring can be one of the most difficult behavioural biases to shake. Despite that, here are a few strategies you can use to limit its influence on your decisions:
- Delay your decisions – Delaying your decisions allows the effect of the anchor to diminish over time as you collect more information relevant to the decision. Instead of buying something because it’s discounted, give yourself some time to consider whether it’s really worth your money.
- Do some research – Some basic research helps you to not rely too heavily on one piece of information (the anchor). Before you buy a stock because your friend says it’s cheap, take some time to research other factors which might be influencing the stock’s value and current price.
- Question the anchor – If you suspect an anchor may be influencing your decision to buy or sell something, take a moment to critically assess the anchor. Ask yourself what the item is really worth, whether you really need it, and if you would pay the discounted price if it wasn’t part of a sale.
Overcoming the effects of anchoring on your decisions is challenging. These strategies can help you think more critically about your decisions, which is always a good idea when managing your money.
Learn more about other behavioural biases which might be impacting your financial decisions in ways you may not realize.
[1] Tversky, A., & Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases: Biases in judgments reveal some heuristics of thinking under uncertainty.Science,185(4157), 1124-1131.
Summary
The anchoring effect is one of the most challenging behavioural biases to overcome. Here’s how it works:
- Anchoring occurs when people rely too heavily on the first piece of information (the anchor) they are given about a situation, topic, or decision.
- This bias influences many areas of peoples’ lives, including salary negotiations and grocery shopping.
- Anchoring can influence many areas of your financial decisions and have a potentially negative effect on your spending, investing, and budgeting.
- You can counteract the effect of anchoring on your financial decisions by delaying your purchasing decisions, doing some research, and critically assessing the validity of the anchor.
