Updated: June 19, 2023
Listen to this episode:
What is the anchoring effect?
The anchoring effect is a cognitive bias where our decision-making is influenced by the first piece of information we receive, which serves as an “anchor” for our subsequent judgments.
Even if the initial information is irrelevant or arbitrary, it can significantly sway our perceptions and choices.
Examples of the anchoring effect:
To better understand the anchoring effect, let’s explore a few examples:
Example 1: Buying a car
Imagine you’re in the market to buy a second-hand car, and you come across one that is priced at P500,000.
Regardless of the car model, the first listed price of P500,000 becomes your anchor. As you continue researching and evaluating other cars, you may subconsciously compare their prices to the initial anchor.
As a result, you may be more inclined to view a P700,000 car as expensive, even though it might be reasonably priced compared to the market standards of that particular car model.
The initial anchor of P500,000 influences your perception and decision-making throughout the car-buying process.
Example 2: Negotiating a salary
Suppose you’re in a salary negotiation for a new job, and the employer starts by offering a relatively low salary of P12,000.
This initial offer becomes your anchor. Even if you had initially aimed for a higher salary, the anchor of P12,000 might influence your perception of what is acceptable.
As a result, you might settle for a salary that’s, say… P16,000, which is higher, yes, but it still falls below your initial expectations.
The anchor provided by the employer shapes your perception of what is reasonable and acceptable in the negotiation process.
Example 3: Buying a house
Suppose you’re in the market to buy a new house and come across a property listed for P6,000,000. This initial listing price becomes your anchor.
As you continue exploring other properties, you might unconsciously compare their prices to the anchor of P6,000,000.
If you find a similar house for P5,000,000, you may perceive it as a great deal because it’s significantly lower than the anchor price. But you did not fully consider other relevant factors, such as the property’s features, its location, the terms and conditions of the seller, or the market trends.
Dealing with the anchoring effect:
Now that we understand how the anchoring effect can impact our financial decisions let’s discuss strategies for dealing with it effectively:
1. Gather multiple reference points.
To counteract the anchoring effect, gather multiple reference points and perspectives before making a decision.
Research comparable prices, salary ranges, or financial benchmarks to establish a more comprehensive view.
By expanding your knowledge and your sample size or database, you can mitigate the influence of a single anchor and make more informed choices.
2. Set clear goals and priorities.
Establishing your financial goals and priorities in advance can help you resist being anchored by external information.
For instance, in our salary negotiation example, even before the meeting, you could have decided that your goal is to have at least a P25,000 salary.
When you clearly understand what you want to achieve, you can evaluate options based on their alignment with your objectives rather than being swayed solely by initial anchors.
3. Take time for reflection.
When faced with an anchor, take a step back and allow yourself time for reflection.
Avoid making impulsive decisions based solely on the initial information. You can reevaluate the situation with a more transparent and rational mindset by giving yourself a cooling-off period.
4. Seek external input.
Engaging with trusted advisors, mentors, or experts can provide valuable insights and perspectives.
They can help challenge and provide alternative anchors, allowing you to consider a broader range of possibilities and make more balanced decisions.
The anchoring effect is a cognitive bias that can significantly impact our financial decision-making.
However, by gathering multiple reference points, setting clear goals, taking time for reflection, and seeking external input, we can mitigate the influence of anchors and make more informed choices.
The 80 Percent Express are special short episodes where I share a financial concept or answer a question sent by a listener.
Ask me a question for the podcast: Send a voice message here.