Anchoring and Adjustment Bias: Why You Can't Let Go of That First Number
Let me ask you something. Is the population of Canada greater or less than 20 million? Now, without looking it up, guess the actual number.
If you are like most people, your guess landed somewhere near 20 million. Not because you know Canadian demographics, but because I just planted that number in your head. That is anchoring. And according to Chapter 11 of Michael Pompian’s book, it is one of the most common traps investors fall into.
What Is Anchoring?
When people need to estimate something they do not know, they start with some number they do know (or were just told), and then they adjust from there. The problem is, they almost never adjust enough. That starting number, the “anchor,” has way too much power over the final estimate.
This is not just some lab curiosity. It affects real decisions made by real professionals with real money on the line.
Real Estate Agents Are Not Immune
Pompian highlights a study by Northcraft and Neale from the University of Arizona in 1987 that I found really telling. They took professional real estate agents, experienced people who appraise properties for a living, and divided them into two groups. Both groups toured the same house. Both got the same 10-page information packet. The only difference? Group one was told the listing price was $119,900. Group two was told it was $149,900.
Then both groups were asked to estimate the property’s value.
Group one (low anchor) came back with an average appraisal of $114,204. Group two (high anchor) averaged $128,754. Same house. Same professionals. A difference of over $14,000 in their “expert” opinions, driven entirely by which arbitrary number was whispered to them at the start.
If trained real estate professionals can be swayed this badly by an anchor, imagine what happens to regular investors making decisions about stocks.
How Anchoring Hits Investors
Pompian gives a good case study. Alice bought stock in Corporation ABC at $12. The stock went up to $20 on a surprise earnings announcement. She thought about selling but did not. Then the stock dropped to $15 after some accounting problems surfaced. Alice did her homework and confirmed that yes, there are real issues with the company. But she still does not want to sell. Why? Because she feels like she “lost” 25% from that $20 peak. She is anchored to $20.
Rationally, Alice should evaluate the company’s current situation and decide based on what the stock is worth today and what its prospects are going forward. The $20 number is history. It has zero relevance to whether ABC is a good investment right now. But anchoring makes it feel like the most important number in the world.
This is something I see constantly. People will say things like “I will sell when it gets back to where it was.” Back to where it was. As if the stock owes them something. As if the market remembers their purchase price.
Four Ways Anchoring Messes With Your Money
Pompian identifies several specific investor mistakes driven by anchoring.
Market forecasts that are too narrow. If the Dow is at 10,500, most investors will predict next year’s range as something like 10,000 to 11,000. They anchor on the current level and adjust just a little. Historical data shows that markets can move much more dramatically than that. But the current number is so present, so available, that it dominates the forecast.
Sticking to old estimates. When an investor decides a company will earn $2 per share next year and then the company stumbles, the investor often does not adjust the $2 figure enough. They know things got worse, but the original number keeps pulling them back. This works in the other direction too. When companies beat expectations, investors anchored to old estimates are slow to adjust upward.
Anchoring on past returns. If the market returned 10% last year, that becomes the mental starting point for next year’s forecast. People adjust a little up or down from there, but 10% remains the gravitational center. Never mind that long-term averages or current valuations might suggest a very different number.
Anchoring on countries or companies. In the 1980s, Japan was the economic powerhouse of the world. Many investors anchored on the idea that Japan would dominate forever. Then Japan entered a decades-long stagnation. Same story with IBM. For years it was the bellwether stock. Investors anchored on that image and were slow to recognize when the world changed.
The Upside: Using Anchoring to Your Advantage
Here is the interesting part. Pompian does not just warn about anchoring. He actually shows how you can use it.
In negotiations, the first number thrown out becomes an anchor for the entire discussion. If you are selling something, start high. If you are buying, start low. Research shows that even extreme anchors influence the final deal. Negotiation experts actually recommend this: be aggressive with your opening position, because anchoring will pull the other side toward you.
And there is an investment strategy built on anchoring too. Securities analysts, when they upgrade or downgrade a stock, tend to adjust their earnings estimates insufficiently because they are anchored to previous numbers. So when an analyst starts upgrading earnings, the real increase is probably bigger than what the analyst says. You can potentially profit by buying stocks that are getting a series of upgrades, because each upgrade likely underestimates the actual improvement. The reverse is true for downgrades: sell fast on the first one, because the analyst is probably underestimating how bad things will get.
What to Do About It
The best defense against anchoring is awareness. That sounds too simple, but Pompian makes a good case for it. Before making an investment decision, ask yourself: am I evaluating this situation based on current facts, or am I holding out for some number that exists only in my memory?
When you are about to sell a stock, check: is your decision based on the company’s actual prospects, or are you anchored to the price you paid, the high it once reached, or last year’s return?
When you read an analyst report, wonder: is this analyst thinking fresh, or are they anchored to their previous estimate and just nudging it slightly?
The anchor is just a number someone made up. Your job is to not let it run your portfolio.
Previous: Mental Accounting
Next: Framing Bias
This is part of a series retelling “Behavioral Finance and Wealth Management” by Michael M. Pompian. Start from the beginning.