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Are you a victim of anchoring?

Anchoring happens, when an individual is presented with a number before he makes a decision.

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The phenomenon leads investors to make mistakes

MUMBAI: Anchoring happens, when an individual is presented with a number before he makes a decision. The number may or may not be related to the situation at hand, but might end up influencing the decision that the individual takes.

Amos Tversky and Daniel Kahneman, the pioneers of behavioural economics, in a study asked the participants to estimate “What proportion of the United Nations is formed by African nations?”

But before the participants answered this question, a wheel of fortune, with numbers from 1 to 100 was spun. And this ultimately had an impact on the estimate that participants made.

As Tversky and Kahneman pointed out, “The median estimates of percentages of African countries in the United Nations were 25 and 45 for groups that
received 10 and 65, respectively, as starting points.”

So a number that did not have any relation to the question asked, ended up influencing the answer that the participants gave.

But how does anchoring impact us in everyday life? The number to which an individual gets anchored may be provided by others or may be drawn from memory or experience.

Investors who bear the brunt of the stock market falling typically fall into the latter category. Having seen the markets fall to the lowest level, their brain remains anchored to the low levels, even when the markets are out of the low levels.

Such investors typically tend to stay away from the markets discounting all positive information that might be coming in. And then there are investors who have seen the markets reach new highs. Such investors remain anchored on to the high levels and keep investing money when the situation has changed and the markets are falling. What is happening in both these cases is that individuals are using the past as an anchor point, though the present may be offering different investment cues.

A very interesting example of anchoring is provided by Gary Belsky and Thomas Gilovich in their book, Why Smart People Make Big Money Mistakes and How to Correct Them, “If you’re on the ‘buy side’ - purchasing life insurance, for example - you’ll be susceptible to any suggestions about normal levels of coverage and premiums. All an enterprising agent needs to tell you is that most people of your age have, say, $2 million worth of coverage, which needs $ 4,000 a year - and that will likely become your starting point of negotiations.”

In such cases, the individual is most likely to end up buying more insurance than he needs as the agent has anchored him on to a higher number.

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