Anchoring Trap: When the First Number Controls Your Choices

Let’s start this article with an example. Akhilesh holds a stock that once touched Rs. 1,000 per share. Over time, the company’s performance became erratic, its profit numbers declined, and the same stock is now trading at Rs. 400. However, Akhilesh continues to hold onto the belief that the stock will go back to Rs. 1,000 someday. That initial price anchors him. Hence, instead of objectively evaluating the company’s performance and marketing conditions, he stays fixated on the past high as if it were the true value of the stock.

*Example for illustrative purposes only.

The behaviour in the above example is quite common in the investment world and is termed as anchoring bias by researchers. Investors tend to set their expectations not on current realities, but on past numbers that may no longer be relevant. Furthermore, this behaviour may not just influence investing, but also shopping, negotiating salaries, and other daily work.

In this article, we will learn more about anchoring bias, its impact and how to avoid it.

Table of contents

• Defining anchoring bias
• Everyday examples of anchoring
• The potential impact of anchoring in finance and investing
• Counter strategies: How to avoid the anchoring trap

Defining anchoring bias

Anchoring bias is deemed to be one of the most common cognitive traps. It happens when people tend to take the starting value to shape their judgment of an unknown quantity, even if the first value may be irrelevant or misleading.

For instance, you may go to a showroom and see a shirt with a price tag of Rs. 2,000 and then you see a shirt with a price tag of Rs. 1,000––you will almost certainly consider the second shirt to be cheap. However, if you had seen the Rs. 1,000 shirt first, you may not have considered it as cheap. Thus, the first price that you saw might have influenced your opinion or anchored you.

*Example for illustrative purposes only.

Also Read: What are Behavioural biases in investing?

Everyday examples of anchoring

Salary negotiations

Many corporate employees may relate to this. When a recruiter sets the first number in a salary negotiation, it tends to frame the rest of the conversation. For instance, when you appear for an interview you have a salary expectation of Rs. 30 lakh per annum but the recruiter starts with an offer of just Rs. 20 lakh per annum. Although you may not have even shared your expectations, the recruiter has quoted the first price and, therefore, set a reference point.

Now, you are more likely to adjust for the middle ground of Rs. 25 lakh per annum. Just by going first, the recruiter potentially saved Rs. 5 lakh on cost to the company, and they didn’t even have to argue.

*Example for illustrative purposes only.

Retail discounts

Brands know how to use anchoring to influence consumers. They put a high original price on a product, slash it with discounts, and make the final price appear much more attractive. Even if the discounted price is higher than market value, the anchor tends to make it look favourable.

Stock market valuations

While investing you must have come across the 52-week high of a stock. If a company’s share falls from Rs. 800 to Rs. 500, many investors may hold on to the stock hoping it will go back to Rs. 800. This anchor bias may make them overlook the changing industry trends and below par performance.

*Example for illustrative purposes only.

Read Also: Behavioral Investing: Emotion vs Strategy in Markets

The potential impact of anchoring in finance and investing

Skewed expectations in investing

Anchoring may lead investors to base decisions on past prices rather than current realities. Someone might refuse to sell a falling stock because they may want to reach closer to their purchase price. However, the market does not consider personal entry points; it reflects broader supply-demand and company fundamentals.

Personal finance decisions

In personal finance, anchoring may cause people to overestimate the value of property based on a neighbour’s selling price, even if their house may have different features or location advantages.

Budgeting

Many budgeting apps set default spending limits for things like rent, gas, or food. These numbers act as anchors, so instead of setting limits based on their actual spending, people may just adjust a little up or down from the default.

Counter strategies: How to avoid the anchoring trap

Be aware of anchoring

Awareness of any risk can be the first step to fighting it off. Simply knowing what anchor bias is may help you reduce its overall impact.

Build healthier habits

Try adding steps in your trading or decision-making process that may push you to double-check before acting. Try asking yourself questions like––are these facts really accurate?

Do proper research

Relying just on the first number or piece of information you see is not an advisable strategy. Try looking at data from different sources. You may collect information from different

sources, compare it and then make a decision that is based on research instead of just your first impressions.

Also Read: Behavioral Finance: Meaning, Types, and Its Importance

Conclusion

Anchoring bias is a reminder that numbers do not just represent value, they also shape perceptions. By focusing on fundamentals, using credible benchmarks and acknowledging behavioural traps, investors and individuals may reduce the pull of anchors and make potentially more informed decisions.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBehere.

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