Personal Finance Essentials
Anchoring Bias
The Psychology of Investing > Anchoring Bias
This is the mistake of assigning importance to random or arbitrary reference points.
If you are wondering whether stock prices are too high right now, you are already assuming that current prices matter in the decision of whether to invest. That assumption may be unfounded.
In one striking experiment, participants were asked to write down a number derived from the last digits of their Social Security number, then use it as a starting point to guess the year Attila the Hun invaded France. Those with high anchor numbers guessed much later years than those with low numbers – even though a Social Security number has nothing to do with ancient history. Our starting point shapes our estimate, even when that starting point is completely arbitrary.
Anchoring in Retirement Savings
Anchoring has real consequences for investment decisions. In one study, when workers were offered a retirement plan with five stock funds and one income fund, 75% of contributions went into stocks. But when a different employer offered one stock fund and four income funds, only 34% of contributions went into stocks. The number of options in each category served as an anchor, pulling allocation decisions in opposite directions – even though the decision should have been based entirely on each investor’s goals and risk tolerance.