Definition

Anchoring bias is a cognitive bias that describes the tendency for individuals to rely too heavily on the first piece of information they receive when making a decision. This initial piece of information can have a profound influence on people's subsequent judgments and decisions that lead to faulty decision-making and a lack of objectivity. For example, suppose you are trying to estimate the price of a toy. You may be inclined to consider the price label as the starting point of your estimate, even if it is not an accurate representation of the toy’s value. This initial piece of information, known as the “anchor” can then skew your perception of the toy’s value and influence the final estimate you arrive at. Note that this first piece of information may or may not be related to the decision itself.

Examples of Anchoring Bias in Our Daily Life

Anchoring bias can occur in a variety of contexts, from guessing the price of an item to estimating the value of a company in a business negotiation. Here are a few examples:

• A person is considering how much to bid on a piece of jewellery at an auction. The first bid they hear is RM10,000, so they anchor their own bid around that amount even though they might have been willing to bid at a higher or lower amount if they hadn’t heard the initial bid
• A fresh graduate is trying to negotiate a salary with a potential employer. They don’t know the pay rates for a degree graduate. If the first potential employer offers them RM3000/month, they may anchor to that low number and negotiate around that offer with other potential employers, even though they may have been willing to pay more given their educational background
• A person is trying to decide who to vote for in an election. They hear a candidate speak and are impressed by their charisma and confidence, so they anchor their decision around that initial impression, even though they may not have considered all of the relevant information about the candidate's policies or qualifications.
• A person is trying to decide whether to trust a friend who has been dishonest in the past. They remember a time when the friend was kind and generous, so they anchor their trust around that memory, even though they may not have considered all of the evidence of the friend's dishonesty

Investment Example

Anchoring bias also occurs in a variety of finance contexts. In the financial world, anchoring bias can lead people to make poor investment decisions. They may be anchored to an initial price or valuation and be unwilling to sell even if the value of the investment subsequently declines. Here are a few examples:

• A person is deciding whether to sell a stock. The current stock price is RM1. However, they remember the price that they paid to buy this stock is RM2, so they anchor their decision around the buying price, even though the stock’s fundamentals have been deteriorating since then. They may not have considered all the relevant information about the company’s performance or macro condition.
• A person is trying to decide how much to invest in a particular mutual fund. They remember that their friend made a lot of money investing in a similar fund, so they anchor their investment amount around what their friend invested, even though they may not have the same risk tolerance or financial goals
• A person is trying to decide whether to buy a particular stock. They remember the stock's high price from a few years ago, so they anchor their decision around that price and expect the current price to rise to the previous high, even though the stock's value may have changed since then and they may not have considered all of the relevant information about the company

In each of these examples, the initial piece of information serves as an anchor, influencing the person's decision, even if the anchor may not be relevant or accurate.

How to Avoid Anchoring Bias

Anchoring bias can be particularly dangerous especially when it comes to decision-making in high-stakes situations, such as investing or making medical decisions. Thus, it is important to reduce the impact of anchoring bias. To avoid anchoring bias, there are a few steps you can take:

1. Be aware of the bias

It is important to be aware of the existence of the bias and its potential influence on your decision-making. Before making a decision, take a moment to think whether you may be relying too much on the “anchor” you received. This will help you remain open-minded and in recognizing when you are at risk of falling prey to this bias.

2. Seek out diverse perspectives

Rather than focusing on a single anchor, it is important to gather feedback and input from others. It can be helpful to seek out opinions from others who may not be anchored to the same initial piece of information as they could provide a different perspective given their diverse backgrounds and experiences.

3. Take a step back before concluding

Don’t just focus on the first opinion that you came across. Take the time to consider a range of options or information available. This can help to avoid you jumping to conclusions based on incomplete or biased information. Overall, the anchoring bias effect can be avoided/minimized by the above-mentioned ways. By taking steps, more accurate and effective decisions can be made through a more balanced and broader view.

The Bottom Line

In conclusion, anchoring bias is a common cognitive bias that can lead to flawed decision-making. Anchoring is everywhere in our lives, so the next time you're trying to decide on something, give enough consideration to all the available information and options. We believe ourselves to be rational and logical. However, the influence of extraneous details on our reasoning suggests otherwise. By recognizing its potential influence and addressing it, individuals can make more objective and balanced decisions.

Author

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This article is written by Dyce Lim, Research Analyst

Dyce is a research analyst in TED Optimus, tasked with researching and performing analysis on companies. She holds a Bachelor of Science in Financial Analysis Degree from Sunway University. During her time at Sunway University, She has participated in the CFA Research Challenge 2019/2020 and won second runner-up in the event. She is also a CFA Level 2 candidate. She is an in-house author of TED Optimus.