December 11, 2023

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Humans use mental shortcuts in everyday life to help process information and make quick decisions. But when it comes to personal finance, they can lead to bad choices.

Some of these undesirable outcomes are the result of “anchor bias,” which can undermine consumers’ rational thinking.

This cognitive bias causes the brain to Over-reliance Form subsequent thoughts and judgments on the basis of initial impressions or figures. In other words, early information “anchors” future choices.

“It’s the idea that you subconsciously remember a number,” said Jennifer Itzkowitz, an associate professor of finance at Seton Hall University who studies anchors in investing. fixed deviation. “It affects future decisions.”

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Humans are more likely to default to these mental shortcuts — known in psychology jargon as “heuristics” — when confronted with complex topics like finance, when consumers can be overwhelmed by information, Itzkowitz said.

“You have to be aware of this bias, or you’re going to fall prey to it every day,” says Bradley Krantz, a certified financial planner in Boulder, Colorado, and founder of the Financial Psychology Institute. Klontz) said.

Here are some of the ways anchoring bias may be at play in your financial life.

1. 401(k) matches can be unintentional anchors

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2. For shoppers, the first price they see is fixed

On the other hand, many retailers are intentionally using anchoring principles to influence consumer buying behavior, Kranz said.

This often happens when stores advertise a sale, he said.

For example, a retailer might mark down a pair of pants from $60 to $30. Consumers tend to judge sale prices relative to the original price, so the new price appears cheap. But objectively speaking, $30 isn’t necessarily a bargain for consumers — especially if a store’s recurring sale means the pants will never be $60.

Another example from the Institute for Corporate Finance: If consumers first see a T-shirt that costs $1,200 and then see a second T-shirt that costs $100, they are likely to think that the second T-shirt is T-shirts are cheap. However, if that person only sees the second shirt, which costs $100, they might not think it’s cheap.

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or, take this example As opposed to planning a vacation, from job site Indeed: A couple might find an all-inclusive ticket to Hawaii for $800 each. They then subsequently found tickets to Puerto Rico for $400 each, but those tickets only included airfare. The couple may choose to travel to Puerto Rico to save money, but end up paying the same amount after including the extra costs of the hotel room and meals.

“The anchor point – the first price you see – unduly influences your point of view,” wrote Tim Vipond, Chairman of the Board of Directors, CFI Education.

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Encouraging investors to start with small investments “could lead to less wealth accumulation in that brokerage account due to anchoring bias,” the paper said.

This was true for all groups, regardless of factors such as income, age and gender, Itzkowitz said.

4. Anchoring bias is a tricky tactic in negotiations

Companies and individuals use anchoring as a common negotiation tactic, for example in connection with salary negotiations or sales, Kranz said.

For example, during the hiring process, a company may try to fix a potential employee’s initial salary level. Any increase from there might feel like a win for future workers, but not as much as employers originally hoped.

Ultimately, the key to combating anchoring bias is to constantly question your financial instincts.

“Assume these things are being used in a nefarious way to rob you of your money,” Krantz said. “Always second-guess yourself.”