Why Investors Do What They Do: Anchoring

So far, we have discussed loss aversion and narrow framing, trouble spots in any investors view of what they are trying to do. They may be investing in their retirement plan or simply making an economic (better yet, one with financial implications) decisions, but we often, as studies have shown, begin from some point of what we know. This is referred to as anchoring.

Unfortunately, anchoring is a bias. It is often included among other similar cognitive biases such as memory bias (which effects how we recall a situation after the fact) and confirmation bias (depends largely of what you already know and uses this information to skew your perception of what really is). Each alters what we see with something we already know and this drives businesses, who want to anticipate what you will do and more importantly, what you will buy and confounds psychologists, who have twisted the lab questions done on test subjects in every conceivable way only to find out that we have numerous cognitive influences mucking up the works.

But anchoring is particularly dangerous when it comes to investor reaction. An anchor is basically an expectation. We are not the kind of shoppers who go into a store, find a good and before we flip the price tag, try and determine what we will pay for it. But it is a good experiment that you can conduct on yourself. Time after time, you will find your expectations of the cost of the good, be it a television or a dress will be altered by what you perceive.

You will try and narrow down your choices to one that seems to be what you think something is worth. But that narrowing of thought, trying to get closer to the price tag (and feeling very smug if your bias towards the cost is exactly what the cost is) will not work across a broad spectrum of goods. In lab tests, subjects merely get "a good" and know little about what it is. But as soon as the item is revealed, adjustments are automatically made.

We generally have no real anchor when we begin investing except for the money we begin the process with. This becomes the anchor if you have nothing in the account. But in a upwardly moving market, an investor can quickly get swept up in a constantly readjusting balance. Once money is made, a new anchor is created in your view of that portfolio.

Investing however is never quite that simple. While we all enjoy growth, we tend to lose focus on the fickleness of the markets and the underlying worth of whatever it is we are buying. If a stock or a mutual fund has had a great run of it, even topping the top ten lists, investors will not see this as the top but the new value on which to anchor their expectations.

Consider what cognitive abilities (or biases) you may have used or borrowed from someone else. You watch the business news channels hoping for a tidbit of relevant information about which security you would like to buy. You peruse the web looking for confirmation of what you would like to believe is true. But what you are really doing is looking for an anchor using someone else's anchor to support your decision.

If analysts make forecasts or predictions based on past performance and then offer the disclaimer that future results are not guaranteed. They have used past results to anchor their bias as to whether things look rosy or the future is bleak for the stock.

Anchoring is tougher on a retirement account largely due to the set and go approach that most investors use in these types of accounts. Unless severe market downturns capture our attention in the news, we tend to leave these accounts to their own devices, channeling a portion of our earnings into them each week.

But when we do look at those quarterly statements, and many of us have for the first time in a while, we have an idea of where we should be. And it will be much higher than is probably reported. That's because we aren't so good at making predictions or estimates.

Look at it this way. Suppose you invested a thousand dollars in an IRA account and added $100 a week to that account. Over the course of 25 years you would have put $114,429 (adjusted for inflation at 3% on the real value of $131,000 actually contributed) in the account. If the money grew over that period at a modest 5%, which for that stretch of time is below average even with last year calculated into the mix, you would have added almost $135,000 in earnings (also adjusted for inflation).

Now suppose your portfolio balance of $249,402 dropped 30% or $74,802. Wouldn't you still be in the black? With an inflation adjusted contribution of $114k, haven't you protected your money and even grew it by $40k. Because you constantly shift your anchor or readjust your estimates higher, your expectations follow.

This is due in large part to a small target. Your balance may have grown substantially since you began investing but what occurred caused you to miss the target. I am not a shooter but I know that when a person does aim and fire, they are often narrowly focused on the target when in fact we should be making broad sight adjustments.

Next up: Mental Accounting

Retirement Planning and Divorce

“After a divorce”, writes E. Mavis Hetherington, author of “For Better or Worse: Divorce Reconsidered” at the beginning of chapter two, “people often imagine that if only they could go back and make a tiny adjustment here of there in the past – not answering a particular phone call, say, or displaying an ounce more resolve in a weak moment – life would have turned out differently for them.”

The reason Ms. Hetherington gets a mention in the book is because of the way she categorizes people into six groups.



The enhancers are who we would all like to be: upbeat, learning from each mistake and turning it to our benefit. In a divorce this would be someone who feels release without regret. In retirement planning, this is someone who understands that things may not be exactly how they envision it but they are nonetheless excited about the prospects of entering a new and mysterious time. This person or couple would gladly downsize and do so without so much as a re-consideration. Free from the confines of work, this person(s) will explore art and gardening with a new or renewed passion. They will volunteer and become vibrant and active members of their community.

And yes, they will have managed this because they saved as much as possible, stuck to a plan and practiced retirement often while they were working. They did not live large even when they had the cash to do so. They did not take unnecessary financial or health risks and pretty much had that single goal in mind for quite a long time.



An enhancer could also be a competent loner. This person was never meant to be confined by marriage and probably will not allow retirement to hold them as well. They forge on without the help or encouragement of others. As the name implies, they do this with some skill.

The good enoughs are like most of us. We take a beating and step right back in, often making the same mistakes as we did previously. In a retirement plan, you will be the one who will be haunted by the missed or mishandled opportunities that may have come your way.



Regret is a mighty potent weight especially as you approach retirement age. Yet, while there is time, and it could take as little as ten years, any retirement plan can be turned around. To become an enhancer, you will need to embrace a sort of lifestyle change.

How little can you live on and not be completely miserable? Not an easy question to ask but look around the dinner table one night and picture yourself asking those kids of yours for a small loan to get by. You may love them but can you rely on them to do well enough to fund their own lives while helping you out as well?



The other direction for the good enoughs is less appealing. Perhaps you would become a seeker. This person stumbles along for most of their working lives and finds that when they no longer want to work, they can not stop. They may have gathered a small pension or tapped their Social Security benefit, but they are finding that life after work may be too expensive. These unprepared souls quickly become depressed.

The libertines actually make a brief appearance in the book as the couple that sold everything for the RV life only to be waylaid by a medical condition that forced them to return to their hometown. Without house and lacking the right kind of coverage (insurance) for the wife’s problem, they were forced to live a wholly different existence than they did when they were working.



In fact, looking back, the libertine might even find work a more desirable place to be. In Ms. Hetherington’s book – and I failed to give credit to her co-author John Kelly and do so here – the libertine rejoices at the idea of finally being free of the confines of a marriage only to find that the experience is fleeting.



And finally, the defeated. These are the hapless workers who labored at the bottom of the wrung and can expect a life of hardship for the foreseeable future. These are not just the hardscrabble people you might expect who end up among the ranks, but those who have had a simple turn of luck, a misfortune, and an I-didn’t-see-that-coming moment.

Can we learn something from divorce? Absolutely. It, all by its lonesome can derail a perfectly good retirement plan. For the woman, statistics prove that you will take the longest time to financially recover. For the man, the cost of recovering can be just as difficult on your health as your wallet. Avoiding a divorce would be the best method of retirement survival.

But the separation events described above apply nicely to the state of retirement. Will you blossom or wither? Will you become regretful or will your ability to survive be enhanced by your newfound lifestyle? You are making the choice right now.