In our journey to make informed decisions, it is crucial to understand the influence of biases. Biases, whether conscious or unconscious, shape our perceptions and lead to one-sided views based on personal experiences and societal influence. In my previous blog post, “The Hidden Influence: Navigating (Confirmation) Bias,” I explored how confirmation bias impacts our financial decisions. Investors tend to favor information that aligns with their existing beliefs while disregarding conflicting evidence. Now, let’s delve into another bias that significantly affects our financial choices: the Anchoring Bias.
Anchoring Bias: What is it and how it impacts
Have you ever purchased a home and focused on a specific price range, say $450,000-$500,000? When you do this, you may have subjected yourself to anchoring bias.
Anchoring bias is a cognitive bias where individuals rely too heavily on initial information during decision making. The initial information acts as an anchor, shaping subsequent judgments and evaluations. In the context of financial decisions, anchoring to the initial information can distort value perception, limit consideration of alternatives, and affect negotiations, often leading to suboptimal outcomes.
Let’s consider a scenario where an investor intends to purchase a property. Starting with an anchor price of $500,000, based on the initial listing price, the investor becomes anchored to this value. However, during the negotiation process, the seller lowers the price to $450,000. The investor perceives this new price as a substantial discount, disregarding other crucial factors such as the property’s condition, location, and current market trends. By fixating on the anchor price and neglecting these important considerations, the investor may overvalue the property and end up paying more than its true worth.
To reduce the impact of anchoring bias on financial decisions, here are a few strategies to try:
Start with Awareness: An individual must first acknowledge bias exists and acquaint themselves with how bias actively impacts decision making.
Analyze: Look beyond the initial anchor and consider a wide range of information, then conduct research around what the decision is being made on.
Seek Diverse Perspectives: I recommend seeking diverse perspectives not only from people, but also from data/different reference points. People can lead one another astray, especially if it’s for selfish gain.
Decision-Making Process: Compare different options against industry standards, historical data, and current relevant market data. This helps establish a broader reference point and reduces the influence of the initial anchor.
- Set Time Aside for Self-Reflection: Reflect on your decision-making process and challenge your own assumptions. Stay mindful of how the initial anchor may be affecting your judgment(s) and strive to remain open-minded.
By employing these strategies, you can navigate the influence of anchoring bias and make more objective choices aligned with your financial goals.
Remember, recognizing bias is not a flaw but an opportunity for personal growth and better decision making.