The Anchoring Effect
And how to lift the weight off our decision-making processes
Was Ghandi more or less than 114 years old when he died? Take a moment to think of a number and say it out loud.
The chances are you probably said a relatively higher number than you might have if I hadn’t primed the question with a number (114). For those who know his age this may or may not have worked but Ghandi died at the age of 78. I recently spoke about group bias and how we are influenced by other people more than we’d like to think. I’m here again to make us all feel a little more stupid and talk about the anchoring effect.
I’m reading Ed Thorp’s A Man for All Markets. An incredibly intelligent and interesting person who beat Nevada at Blackjack when he created card counting, created the world’s first wearable computer (with Claude Shannon), built a device to predict where the ball would land on a roulette wheel and took Wall Street’s pants down with his investing techniques. However intelligent he was, he was still susceptible to anchoring:
My second mistake for thinking, my plan for getting out, which was to wait until I was even again. What I had done was focus on a price that was of unique historical significance to me, and only me, namely my purchase price. Behavioural finance theorists, who have in recent decades begun to analyse the psychological errors in thinking that persistently bedevil investors, call this anchoring (of yourself to a price that has meaning to you but not the market). Since I really had no predictive power, any exit strategy was as good or bad as any other.
Daniel Khaneman is one of those behavioural theorists and his book Thinking Fast and Slow has some interesting examples of how we fall for this trick time and again.
Here’s an excerpt from the book:
Anchoring effects explain why, for example, arbitrary rationing is an effective marketing ploy. A few years ago, supermarket shoppers in Sioux City, Iowa, encountered a sales promotion for Campbell's soup at about 10% off the regular price. On some days, a sign on the shelf said LIMIT OF 12 PER PERSON. On other days, the sign said NO LIMIT PER PERSON. Shoppers purchased an average of 7 cans when the limit was in force, twice as many as they bought when the limit was removed.
I’m sure we all painfully remember the great Covid toilet roll fiasco where manic people would buy every single piece of toilet roll they could physically carry like it was gold leaf.
Still not convinced? Most people aren’t, they’re *not* stupid enough of course. Here’s another example.
Powerful anchoring effects are found in decisions that people make about money, such as when they choose how much to contribute to a cause.
To demonstrate this effect, we told participants in the Exploratorium study about the environmental damage caused by oil tankers in the Pacific Ocean and asked about their willingness to make an annual contribution "to save 50,000 offshore Pacific Coast seabirds from small offshore oil spills, until ways are found to prevent spills or require tanker owners to pay for the eration." This question requires intensity matching: the respondents are asked, in effect, to find the dollar amount of a contribution that matches the intensity of their feelings about the plight of the seabirds. Some of the visitors were first asked an anchoring question, such as, "Would you be willing to pay $5 before the point-blank question of how much they would contribute.
When no anchor was mentioned, the visitors at the Exploratorium― generally an environmentally sensitive crowd-said they were willing to pay $64, on average. When the anchoring amount was only $5, contributions averaged $20. When the anchor was a rather extravagant $400, the willingness to pay rose to an average of $143.
The difference between the high-anchor and low-anchor groups was $123. The anchoring effect was above 30%, indicating that increasing the initial request by $100 brought a return of $30 in average willingness to pay.
In the first example with Ed Thorp, he lost half of his investment. Now if the investment thesis was done correctly and no fundamentals had changed this could have been an amazing opportunity to buy more shares but he bought something he didn’t understand in the first place and then when the shares plummeted made up a number for cashing out that was significant to only him, getting even.
In the second example, people are buying more tins of soup than they normally would have because of a promotion. I think it’s this one, more than any other that we’ve all fallen victim to. Many times. In fact, my wife last night bought some gym pants after an advert on social media popped up with ‘80% off for the next X hours’. Of course, she bought them. Scarcity was created (time) as well as financial savings. I’ll not mention the fact she already has more than enough gym pants!
In the third example, people were asked how much they would contribute to a cause that was deeply important to them. Some people were primed with a $5 question and others with $400. The difference in what people were willing to contribute was staggering. A swing of $123.
There’s another example in the book where there’s a house up for sale. Estate agents and students were asked to walk the house and study the pamphlet detailing the specifications of the house. An asking price was given where the number was high for half of them and low for the other half. They were then asked to give their recommended price for what they would sell the house at. The people who saw the higher asking price were generally higher and the people who saw the lower asking price were generally lower. There was a swing of 41% between the two groups. But here’s the kicker. When they were asked about the influence of the asking price the students were willing to admit that they were influenced by price. The professionals? Denial. The price ‘apparently’ did not influence them.
Steps to combat anchoring
Luckily, there are a few steps you can take to help stop the force of anchoring when you make decisions.
When negotiating for a house, a car or at a bazaar on holiday the first mover has an advantage. If the estate agent asks you to cough up £250,000 for a house that’s worth £240,000 and you counter at £200,000 the chances are you’ll both be a bit p*issed off and get nowhere. If someone makes an outrageous proposal to you simply tell them so and walk away. Make a scene if you wish, but let them know that you will not negotiate with that starting number.
Alternatively, you can counter with the absolute minimum that you believe they will take. In this example maybe £230,000 at a push but probably more like £235,000. After all, we all know people stick something on top of what they are selling because they KNOW people will always try their luck.
Think objectively. Having time to analyse your decision-making process by using your more logical side of the brain may help you spot this anchoring in action. Why are you attached to the ridiculous counteroffer of £200,000 that you made when you know yourself it’s nonsense? Go away, do some research on house prices in the area that are similar and have sold, look at the maximum that you can afford and re-counter with something just less than that to give yourself a slight margin of safety.
In hindsight (my least favourite biases) this is easier said than done. For I fell victim to the anchoring effect last weekend. I was in a lovely little pub with my wife when she erratically told me two pints in that Singapore Airlines were flying direct (unheard of) from Manchester to Houston, Texas for a staggeringly low price. We hadn’t intended to go this year and certainly not in October/November but it was almost half of what we paid (anchor) two years ago when we went to Texas for our honeymoon.
I won’t tell you what we did but be quick, hurry before they change their minds!
*Photo by Vladimir Srajber
