If I had to ask two groups of people to guess how old Albert Einstein was when he died, I could influence the outcome of the guesses with a fair amount of certainty. How so? Well, by utilising an age old cognitive bias called anchoring of course. By instilling a mental anchor I can influence one of the groups to give a substantial higher estimate than the actual age of 76. For those of you who work with big groups, feel free to try this exercise yourself.
First ask Group A whether they think Einstein was older or younger than 120 when he died. Then you ask the group to guess the actual age at which Einstein died and determine the average answer
Ask Group B: Do you think Einstein was older or younger than the age of 65 when he died? You then ask them to guess the actual age at which Einstein died too and determine this group’s average answer.
What you will find is that group A will come up with a considerably higher guestimate for Einstein’s age at death than that of Group B. Why is this? The first question was merely to anchor each group’s thoughts on a number (120 or 65). From this anchoring point, the natural process for a human-being’s brain is to adjust his “guess” upwards or downwards from this anchor.
So what is the relevance of this experiment to investments? The relevance of anchoring is much more important than you think. Clever marketers often consciously place anchors in our minds, and we unconsciously subject ourselves to these anchors on a daily basis which influence our financial decisions, spending patterns and behaviours. Let’s look at a few examples:
• Back in 2007, you bought a plot at the height of the property bubble. You initially paid R 1 million for the plot and during 2008 you realised that it was a HUGE mistake. Meanwhile, plots around you are being sold, fetching only between R 800 000 and R 900 000 and you quite simply think that they have lost their marbles. You simply shrug off any offer below R 1 million …regardless of what the market is telling you a realistic price in current conditions would be. You have paid R1million and that created an anchor. You will rather keep the property for 10 years and sell it for R1million 10 years later (incurring all sorts of running expenses to add injury to insult) than sell for R800 000 a year after you bought it. The former obviously costing you a big amount of dough in the form of opportunity cost.
• You bought a share for R 10. Initially it rocketed to R 15 per share, but after a while it begins to decline and stabilises at around R 7 per share. You refuse to sell your share for less than R 10, because this is what you paid for it (your anchor) and decide to wait until it recovers. Eventually, it reaches R 10 a share again. Relieved, you get rid of it as soon as possible, irrespective of whether R 10 reflects the true value of the share at that point or not.
• You are interested in buying a house and the property agent shows you 4 houses. The first house is precisely what you were looking for, but totally overpriced and way out of your budget. The second house has some of the fine characteristics and features of the first house, but at a considerably more affordable price. What is the likelihood that the second house now looks like a bargain and perfect in terms of your needs just because it is similar to the first house but significantly cheaper? Can you see how the first house might have been “planted” to create an anchor in your head in terms of price or “value for money”?
• Your spouse buys a pair of shoes for R 4 000, merely because the original price of the shoes was R8 000 and it was marked down by 50%. Would she/he have bought the shoes if the R8 000 was not anchored in his/her unconscious mind? In other words if the full price of the shoes was in fact only R4 000 (and never marked down, and therefore no price-anchoring at play), would she/he still have bought it?
By now you should get the picture. If you are still under the illusion that you come to buying decisions on your own terms, think again. Anchors are used more frequently than not in order to establish a starting point from where values are adjusted either upwards or downwards in our subconscious minds.
Consider the following guidelines when faced with the effect of anchoring mentioned in the examples above.
• Plots: When you realise you made a mistake in terms of price, no amount of waiting can change the initial error. Realise your mistake, learn from it, cut your losses and try again. The opportunity cost of sitting and waiting for a recovery, can be massive.
• Shares: The price that you paid for a specific share is irrelevant when assessing whether you should sell or hold on to it. The intrinsic value of the share (current price relative to value) should be the main determining factor in your decision to hold, sell or buy more. The same principles as with the plot example applies with regards to opportunity cost.
• Property: Ask the agent to give you a rundown of the different properties that she intends showing you, but WITHOUT the prices. Selectively sort the houses in terms of preference and view them in this order. After viewing, rank the houses again and try to figure out what you would be prepared to pay for them and write these numbers down next to each property. Only then do you ask the agent to provide the prices.
• 50% Discount: If you become aware of a 50% sale at your spouse’s favourite retailer, lure her into the bathroom and lock her inside. Feed her through the bathroom window until the promotion has passed.
On a more serious note. Anchors are made to keep boats in their place. If you are not careful, anchors can also keep your financial boat from ever leaving the harbour!
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.