4 Tips to Help You Avoid Anchoring Bias When Investing

By Myles Leva

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Last Updated: March 21, 2022

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Overcoming bias is a challenge many people face in their jobs and other activities. In investing, bias is a force that can be particularly damaging. The consequences of too much bias in decision-making will affect each investors’ bottom line.

Today, let’s look at one of the most pervasive forms of bias: anchoring bias.

 

 

What is the Anchoring Bias Definition?

Anchoring bias is a natural psychological phenomenon. It causes us to automatically rely too much on the first piece of information we get about something.

Anchoring bias comes out in many different situations in our lives. However, it is seldom more damaging than it is when we allow it to influence our investments.

In terms of investing, anchoring bias means basing investment decisions too heavily on one initial piece (or collection) of information. When you make a decision based on information you haven’t taken the time to double-check, you suffer several consequences. We will get into more detail about that soon.

If you’re a beginner investor, you will soon learn that removing bias from decision-making is an ongoing but necessary struggle. There are several biases that affect investment decisions. But anchoring bias is the focus of today’s article.

 

Why is Anchoring Bias Bad?

In short, anchoring bias is bad because it costs you money.

Anchoring bias can result in financial loss in a few ways. It can cause you to simply make a rash, unwise decision. Or, it could reduce your earnings by detracting from the benefits of a more complete analysis.

Anchoring bias, as the name suggests, causes us to attach our logic too early on. With the original collection of information being the anchor, we are anchoring ourselves on an incomplete reality. This causes us to miss the complete, objective failure. When this applies to investing, that means higher risk and lower profits.

This logical flaw which we seem to naturally gravitate towards in many cases can come about in a few ways.

 6 Emotional Biases You Should Avoid When Investing in the Stock Market

 

 

How Do You Overcome An Anchoring Bias?

Now that you know how anchoring bias works, it’s time to shake it off. Here are some tips that can help you fight the negative effects of this pervasive bias. We will also provide a few examples of anchoring bias affecting investment processes.

 

1. Acknowledge Your Bias

Before we really dive into it, we cannot overstate the importance of recognizing bias. You, like everyone else, have your biases. There is no shame in admitting that. Bias is an inevitable part of all decision-making processes human beings have ever engaged in.

Anyone who thinks they are free of any biases is more biased than most other people. Believing you have no biases makes you both wrong and less effective at tackling any challenge.

Statisticians regularly try to minimize many types of bias in their work. But one of the first parts of becoming a statistician is recognizing that bias exists and cannot be removed. Only after that can you truly fight bias.

 

2. Stop Using Shortcuts

Anchoring bias is more likely to take shape when you are looking for faster, simpler answers. But life is complex, and investment markets are even more so.

Anchoring bias forms as a natural need we feel to form mental shortcuts around complex issues. When you start tackling a problem and fail to do so as quickly as you thought you would, there are a few possible responses:

  1. Building a fast-track to finding the solution, saving your ego but sacrificing a chance at a larger understanding
  2. Accepting defeat and giving up
  3. Pausing and realizing it will take more time and effort than you originally thought to choose the correct course of action

While you’re certainly a hard-working person, your anchoring bias is most likely a blind spot that allows you to choose option #1. You likely don’t realize you’re doing it, even while you do it.

As an investor, you can actively shift your thinking to one reliant on diligence more than on shortcuts. With an active focus on diligence, you are less likely to give in to any kind of bias. So:

  • Double-check and fact-check your assumptions
  • Assume there’s always more to know
  • Look at all factors at play

 

3. Use Better Anchors

To some extent, everyone needs to anchor their belief structure. Even Charlie Munger and Warren Buffett do so. However, you can change your anchor into one that respects the complexities of investment markets.

An ideal anchor is a good reference point that also admits having an incomplete answer to what the full solution is. In terms of investing, a good example is to focus on macroeconomic factors instead of broad indicators that don’t tell the full story.

In this way, you can use anchoring bias to your favor, tricking your brain to use the bias to your advantage.

Anchor your thoughts in diligence, skepticism, caution, and macroeconomics.

 

4. Use Objective Resources

When conducting your analysis and forming your opinions, focus on objective data. We’ve alluded to this in bringing up the importance of macroeconomic indicators. But in this sense we mean focusing on the resources you have access to that are objective.

The problem with anchoring bias is that most anchors are based on chance or coincidence. Correlation very often does not equal causation. So, you can easily find yourself taking in information that does not meaningfully relate to the intrinsic value of a security.

One of the worst kinds of resources is the kind that causes confirmation bias. That is, anchoring your thoughts based on past performance. You look back, see a pattern, and assume it will continue. Many investors fall victim to this mentality. This can lead to:

  • Pulling the trigger and making an investment decision too soon
  • Delaying selling even though it makes sense to do so
  • Taking more time to adjust to newer, better information

Anchoring your process on current, objective information is another good trick for beating anchoring bias.

 

Conclusions

Anchoring bias is something we’ve all faced in one situation or another. There’s no shame in losing to your biases, so long as you recognize that they exist, and you do something about them. In terms of anchoring bias, recognizing it is a key step in avoiding this challenge.

Anchoring bias is similar to confirmation bias, but it plays a uniquely worrying role in investing. You can avoid falling into the anchoring bias trap by playing some tricks on yourself. Using the same triggers that bring about anchoring bias, you can largely fix it and use it to your advantage. 

Photo by [ik] @invadingkingdom on Unsplash

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