Let’s say someone asks you a benign question such as, “Are there more or less than 100 countries in Africa?” What would your answer be?
Most people would say, “less,” and they’d be right.
You are then asked a follow-up question, “So how many countries are in Africa?”
Think about it for a moment and remember your guess. The answer will be revealed at the end of this article!
As you may have realised, the question is a set-up. By first asking you if there are more than 100 countries, you are being “anchored” to a number.
Although you know that number sounds implausibly high, by stating the number as part of the question, evidence suggests that it will influence your next guess.
Two well-known psychologists, Amos Tversky and Nobel Prize winner Daniel Kahneman (Tversky would also have won had he lived) showed this in a paper titled, “Judgment Under Uncertainty: Heuristics and Biases¹”. The paper was published in the journal Science, and showed that even random information, such as the last two digits of your phone number or the outcome of spinning a wheel, could affect someone’s guess as to how many countries are in Africa.
According to Investopedia², anchoring is “a behavioural finance term to describe an irrational bias towards an arbitrary benchmark figure.” Perhaps a better definition is provided by the Corporate Finance Institute that says, “anchoring bias occurs when people rely too much on pre-existing information or the first information they find when making a decision.”³
The Decision Lab⁴ provides a useful example of anchoring bias in real life, “Imagine you’re out shopping for a present for a friend. You find a pair of earrings that you know they’d love, but they cost $100, way more than you budgeted for. After putting the expensive earrings back, you find a necklace for $75, still more than your budget, but hey, it’s cheaper than the earrings!”
There are plenty of non-financial examples as well. One study showed that the amount of food participants in the study wanted to eat was influenced by whether they first imagined being served a large or small portion.⁵
Many of us have similar stories. While travelling in the Middle East (when travel was a thing) a colleague saw an artefact he liked and asked the boy tending the shop what it cost. The answer was absurdly high. When he turned to walk away, the boy called out with a steep discount. The haggling began and the man walked away with the artefact thinking he had negotiated a discount in the order of 75%. He was dismayed to find later that he paid double it’s true price. He bought into the high anchor.
In New Zealand, there is one prominent consumer goods store where everything… everything… always appears on sale. Now, if every item you sell at your store is at a sale price, then the sale price isn’t the sale price at all… it’s the real price. But it feels good to think you got it on sale, doesn’t it? This is also a form of anchoring.
We have often seen the effect of anchoring on the behaviour of individual investors. Some may even sound familiar.
A common example is an investor who has a large amount of money sitting in the UK which they want to spend or bring over to New Zealand. They are hesitant to exchange the money at the moment because the exchange rate is close to 2:1 ($2 NZD for £1). They remember the 3:1 days and want to wait until those days come back.
Here an investor is anchored to a ratio from the past. It’s possible that the exchange rate will return to that level but that will have nothing to do with the past, only with the future. By the way, the rates haven’t been at 3:1 since 2006.
In another example, an investor says to us, “New Zealand is a better place to invest because it achieves higher returns.” Whilst this has been true in aggregate over the last decade, what does that mean about the future? “Very little”, we’d say. Other businesses around the world are not going to capitulate their plans for growth to make it easy for New Zealand businesses to perform better. This year, the NZX 50 has had returns hovering around 0%, whereas MSCI world returns are up over 10%.⁶
So how do you avoid anchoring bias? Unfortunately, it’s very difficult. Anchoring bias is one of the most common and well researched of all cognitive biases. Essentially, going with the bias feels good and intuitive. Countering the bias feels awkward. Because of this, asking someone to think it over won’t often work as thinking about it just reinforces the emotion behind the bias.
One method that could work was outlined in a 20-year-old study entitled, “Overcoming the inevitable anchoring effect: Considering the opposite compensates for selected accessibility”.⁷ In this study, the authors show that individuals who were car experts were asked if the price of a car was too high or too low (the initial price of the car was the anchor). They were then asked to provide a better estimate. However, before they gave their estimate, they had to articulate their argument against the anchor price. Those that did were less susceptible to the anchor than those that gave no counterargument.
Let’s illustrate this with an idea that is anchored in information that may be out of date. You give a counter idea, but they just aren’t willing to take on new information. You say to them, “firstly share why your idea is right. Then share why my idea is wrong. Next share why my idea is right, then last share why your idea is wrong. At the end let’s review together all the arguments and decide which to go with”. By making the argument themselves, against their own idea, they become willing to accept new information.
The most common method to overcome the effect of anchoring is experience. Experience provides some counter to an anchoring bias. For example, if we knew from experience what artefacts in Middle Eastern shops should cost, we’d be less likely to overpay. In that example, it was inexperience that allowed the anchor to be so influential.
When we talk with clients, we try to work through all the anchors they have in their mind regarding recent market activity or prior investing experiences. If necessary, we help articulate the arguments and provide the evidence that leads to prudent choices.
While we’re not saying that we aren’t influenced by anchoring, years of experience teaches you practical wisdom, caution, processes and governance which provide the means for careful and thoughtful choices.
Speaking of experience, some of you probably knew from experience that there are exactly 54 countries in Africa. If you didn’t, anchoring suggests more of you guessed high than low. Either way, knowledge may help overcome the anchoring challenge and if it doesn’t, it may win you a point on a future pub quiz.
¹ Tversky, Amos, and Daniel Kahneman. “Judgment under Uncertainty: Heuristics and Biases.” Science 185, no. 4157 (1974): 1124–31. http://www.jstor.org/ stable/1738360.
² https://www.investopedia.com/terms/a/anchoring.asp
³ https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/anchoring-bias
⁴ https://thedecisionlab.com/biases/anchoring-bias/
⁵ Marchiori, D., Papies, E. K., & Klein, O. (2014). The portion size effect on food intake. An anchoring and adjustment process? Appetite, 81, 108-115. https://doi. org/10.1016/j.appet.2014.06.018
⁶ Correct as of end August 2021
⁷ Mussweiler, T., Strack, F., & Pfeiffer, T. (2000). Overcoming the inevitable anchoring effect: Considering the opposite compensates for selective accessibility. Personality and Social Psychology Bulletin, 26(9), 1142-1150. https://doi. org/10.1177/01461672002611010