Anchoring Bias in Financial Decisions
What is Anchoring?
Anchoring is over-relying on the first piece of information encountered (the "anchor") when making decisions, then insufficiently adjusting away from it.
Key Insight: Even completely irrelevant anchors influence judgments.
How Anchoring Works
Process:
- Initial number/value presented (the anchor)
- Brain latches onto this reference point
- Subsequent estimates adjust from anchor
- Adjustment is insufficient
- Final judgment remains biased toward anchor
Investment Anchoring Types
Purchase Price Anchoring
Most common and costly anchor: The price you paid.
Example:
- Bought stock at ₹500
- Currently trading at ₹350
- Fair value (fundamental analysis): ₹320
Anchored thinking: "Won't sell until it hits ₹500 again (break even)"
Rational thinking: "Is this worth ₹350 now? No, sell and redeploy."
Error: Market doesn't care what you paid! Purchase price is irrelevant to future value.
52-Week High/Low Anchoring
Investors anchor on arbitrary historical extremes:
- Stock at ₹80, was ₹150 (52-week high)
- Feels "cheap" relative to ₹150 anchor
- Reality: Maybe ₹150 was bubble, ₹80 is fair or still overvalued!
52-week range is just historical trivia, not fundamental value.
Analyst Price Target Anchoring
When analyst gives ₹800 target:
- All investor judgments revolve around ₹800
- ₹700 feels "cheap" (vs anchor)
- ₹850 feels "expensive" (vs anchor)
- Forgot: Analyst might be wrong!
Round Number Anchoring
₹100, ₹1,000, ₹10,000 feel like "natural" targets.
- Sensex 100,000 feels like milestone to sell at
- Reality: 100,000 is no more special than 97,342. It's arbitrary!
Experimental Evidence
Classic Study (Tversky & Kahneman):
Spin wheel showing random number (10 or 65). Then ask: "What % of African nations are in UN?"
Results:
- Shown "10": Average answer = 25%
- Shown "65": Average answer = 45%
The random anchor shifted estimates by ~20 percentage points!
Investment Impacts
| Anchor | Behavior | Cost |
|---|---|---|
| Purchase price | Hold losers to break even | Opportunity cost, further losses |
| 52-week high | Think current price is "cheap" | Buy overvalued stocks |
| Historical peak | "Gold hit $2,000 before, will again" | Ignore changed fundamentals |
| IPO price | Think ₹110 is expensive for ₹100 IPO | Miss good investments |
Real Estate Anchoring
Indian Example:
Apartment listed at ₹1.5 crore. After negotiation, buy at ₹1.35 crore.
Feel happy about "₹15 lakh discount!"
Reality: Listing price was deliberate anchor, likely inflated. Comparable apartments sell for ₹1.25 crore. You overpaid by ₹10 lakh while feeling smart.
Sellers use anchors strategically!
Breaking Free
Ignore Sunk Costs
Purchase price is sunk cost—money already spent, cannot be recovered.
Right question: "If I had cash today, would I buy this stock at current price?"
Wrong question: "When will I break even?"
Absolute Valuation
Calculate intrinsic value independently before seeing market price.
Use DCF, comparable transactions, asset-based valuation—anything that doesn't reference current price or your purchase price.
Question Every Anchor
When you catch yourself thinking "expensive compared to X" or "cheap vs Y":
- Ask: "Is X/Y meaningful or arbitrary?"
- Usually arbitrary!
Consider Opposite Anchor
Anchored high? Force yourself to consider low anchor.
- Stock was ₹150, now ₹80
- Don't just think "cheap vs ₹150"
- Also consider: "What if fair value is ₹60?"
Pre-Commitment
Set rules before anchor is introduced:
- "Rebalance when allocation drifts ±5%"
- "Stop-loss at -20% from purchase"
- Removes in-the-moment anchoring
Key Takeaways
- Anchoring: Over-relying on initial values, insufficient adjustment
- Most common: Purchase price anchor (waiting to "break even")
- 52-week: Historical extremes are arbitrary, not meaningful
- Targets: Analyst targets and round numbers bias perception
- Protection: Ignore sunk costs, absolute valuation, question anchors
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