The Anchoring Bias

Are you aware that you subconsciously use an arbitrary benchmark when making value judgments?

We do this all the time in all areas of our life. But it is costliest when we do this with our investments, particularly in the stock market.

In an experiment, participants were to guess the selling price of random items. Before showing the items, the researchers asked the participants to write down their telephone numbers. Interestingly, participants whose phone numbers started with higher numbers tended to guess higher than those with phone numbers that started with lower numbers. The researchers concluded that just by seeing (or even thinking about) higher numbers, people tended to guess higher numbers. It's hard to believe because it does not make any sense. But it is an interesting behavior and has been confirmed by many studies.

How does anchoring bias manifest in our day-to-day lives? Have you ever experienced shopping for a shirt selling for $50 that has a "reduced from $100" label? How did that label affect your thinking? Did you, like most people, think you are getting a bargain?

The $100 price is there for a reason: to anchor your thinking to that value. You think you are saving money, but your bank account sees the math differently.

Something is only worth what another will pay. The shirt did not sell for the original price of $100 because nobody thought it was worth $100. It is the reason the shirt is now selling for $50. You could have easily thought you were getting ripped off, but because of the anchoring bias, you think you are getting a bargain.

To make better decisions, you should also compare $50 to zero: you could choose to walk away and spend $0. But that $100 price tag is there, acting like a beacon in the back of your mind, fooling you that it is a better deal than what it is.