Anchoring

In 1974, two psychologists, Amos Tversky and Daniel Kahneman, published the paper, “Judgment under Uncertainty: Heuristics and Biases.” In it, they discuss biases inherent in all of us that, consciously or not (usually not) impact our decision-making. All were groundbreaking at the time and remain relevant today, but the most noteworthy may be the idea of “Anchoring”.

Though Dr. Tversky passed away in 1996, Dr. Kahneman expanded on their ideas in a 2011 book, Thinking, Fast and Slow, and used an example of two real estate agents being asked to assess the value of a home in order to explain anchoring. Prior to submitting their valuations, one was shown an asking price that was quite high, the other, quite low. The one who saw the higher price submitted a valuation considerably higher than the one that was put forth by the agent who saw the lower asking price. Each was influenced by the first value they saw; they anchored to it. This phenomenon isn’t isolated to real estate, of course. All of us have a tendency to place an emphasis on numbers or facts that, in actuality, have very little to do with what’s going on, simply because they are what we first saw, learned, or remember the most.

The chart below shows the value of the S&P 500 index going back to 1996. I’ve mocked it up by adding a blue line that reaches from March 9th, 2009, the lows of the Financial Crisis, to November 25th, 2022. I’ve also added some red shading, to reflect the significant, though short-lived, losses that occurred at the beginning of the Pandemic, and green to depict the rally that followed.

What’s most noteworthy is how linearly the S&P 500 has appreciated over the last thirteen and a half years; In fact, it’s up more than 400%. The blue line I’ve added goes up like a rocket from the March, 2009 lows, through the February, 2020 highs, to where we are today. It’s moved exactly how you want your investments to: up and to the right.

It isn’t so simple, though, due to what Drs. Kahneman and Tversky uncovered nearly 50 years ago: we’ve anchored to the December, 2021 highs, and that our net worth has dropped is disheartening. For some, it’s downright scary. These feelings can lead us to question the point of investing, or look elsewhere for ways to shore up our account balances. Shoot, none other than the Wall Street Journal recently proclaimed that the “Classic 60-40 Investment Strategy” has fallen apart.

In a year like this, it’s important to understand how our biases are impacting the way we may be feeling. For example, instead of focusing on the market’s performance this year, how about focusing on these facts:

    • Since March, 2009, the stock market is up more than 400%.
    • Since the start of the global Pandemic, the S&P 500 is up 19%.
    • Since March, 2020, the stock market is up more than 80%.

Stretching out the period of time you focus on makes all the difference. Carl Richards draws it best:

I don’t want to dismiss or downplay the nervousness or anxiety you may be feeling. The reason the idea of anchoring received so much acclaim in 1974, and continues to be discussed, is because it impacts all of us, and it’s real. For many reasons, we are predisposed to be uncomfortable with what’s taken place this year.

In Dr. Kahneman’s 2011 book, which I mentioned earlier, he submits that we cannot ever rid ourselves of biases like anchoring. He’s very clear, in fact, that he himself continues to fall victim to them. He does, however, describe some tools we can use to push back on their effects. None of them apply specifically to personal finance, though there is one in particular I like, mainly because it’s so simple. Rather than imagining things will continue on, i.e., the stock market will fall forever, a “strategy of deliberately ‘thinking the opposite’ may be a good defense….” The market won’t fall forever. You may find it helpful to say the opposite, whatever it is, out loud, and to really mean it.

We like to think of ourselves as another tool you can utilize. Sometimes that means being an outlet for your concerns, to just listen. Other times it means being the one to say the opposite. The market won’t fall forever. Inflation will subside. The economy will be ok. Everything will be alright. 

We mean it.

 

The content above is for informational and educational purposes only. The links and graphs are being provided as a convenience; they do not constitute an endorsement or an approval by Beacon Wealthcare, nor does Beacon guarantee the accuracy of the information.

Ryan Smith
[email protected]

Born and raised on the North Shore of Massachusetts, I moved to Raleigh in 2011 to marry my wife, Emily. We have two kids, Jack and Gwen, and are members of Church of the Apostles in North Raleigh. I have been a Financial Advisor since 2005 and earned a Master’s of Science in Financial Planning from Bentley University. Soon thereafter I became a CFP® professional and received my Retirement Income Certified Professional® designation in 2015.