Our minds work in funny ways, and one of the most fascinating traits involves our tendency to hang our decisions on irrelevant information. Behavioral psychologists call this tendency “anchoring.” We see it in the investment markets when investors come to regard the price at which they bought an investment as more significant than any other price, or when their predictions for a specific investment depend solely on its price today. Researchers have conducted fascinating studies showing how an irrelevant number can influence decisions just because the number is presented first.
For instance, the late Amos Tversky and Daniel Kahneman, who teaches at Princeton, asked people how many African nations were in the United Nations. Before allowing an answer, a wheel of fortune with numbers from one to 100 was spun and participants were asked how much higher or lower their answer was than the wheel’s number. Even though it was obvious that the number on the wheel had no relation to the answer, participants who got a 10 on the wheel, for instance, gave a median answer of 25 nations, while those who got a 65 on the wheel gave a median answer of 45. It appears that the wheel influenced their answers.
Even experts can be fooled by starting numbers. In another study two sets of realtors were shown a house and given a packet of information on it. One group was told the house listed at $69,500. The other group was told it listed at $83,900. Despite being shown the same house with identical information except for the listing price, the realtors who were given a higher listing price gave a much higher median estimate of value.
Investors often get fooled into holding rather than selling a stock because they are waiting for its price to “come back” to the price they originally paid. That’s because they anchored on their initial purchase price, attaching more significance to it than does the rest of the stock market. Even though the stock they bought for $130 currently sells for $65—and most other investors believe it is only worth $65—the anchored investors stubbornly believe their stock is supposed to sell for $130. This doesn’t always happen with an initial purchase price. Another example is when a stock reaches a high and subsequently drops, some investors might consider it a bargain and buy at the lower price, assuming it will climb back up to the previous high.
Experts warn that you may be subject to anchoring bias if you can’t sell investments for less than you paid or if you rely on sellers to set a price rather than assessing value for yourself.
