Anchoring: when bias weighs on your returns

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

Investors are prone to the odd day dream, especially around the stocks they plan to sell that will let them jet off into the sunset. “I’ll sell when it gets to…”, “I’ll only buy if it drops to…”, “Well last year it went up 10% so if I get the same for the next few years then…” - if you haven’t started a few thoughts like this, you’ll probably still have heard a few friends announce their strategies in a similar way.

It’s understandable. We crave checkpoints, signals, chapters to signpost the beginning and end of our investments. The problem is that these markers are so rarely created through research and tend to pop up more from the emotional part of our brain than the thoughtful one.

Anchoring is a well-known cognitive bias that prompts investors to fixate on fairly meaningless reference points in their stock stories as a short cut, instead of calculated, thesis-backed targets. So, why does it affect us and how do we stop it harming our returns?

Our brains are lazy, vulnerable to suggestion and constantly looking for short-term comfort. That mix makes investing based on detailed research all the more difficult. In a blizzard of numbers, which we should really avoid long enough to delve into the company accounts ourselves, our brains instead clutch at the latest share prices like the final round on the Crystal Maze.

Read more:

- When should I sell my stocks?

- How to spot a pump and dump scheme

- Six things to do before you start investing

It’s why we so often congregate around neat, whole numbers, making plans to ‘buy when shares hit £100’ or ‘sell 10% of the holding if shares go up by £10’. In the absence of actual homework on the stock, it feels comfortable.

The trouble is, the market doesn’t know our plans and even if it did I’m not sure it would be kind enough to rise and fall in line with our tidy turning points.

It’s important we realise the market doesn’t owe us anything. When we anchor to certain prices we often insert ourselves into the story as if our entry point means something to the wider market. Our buy price means nothing to anyone but us so refusing to sell because a certain increment of our initial investment hasn’t been hit, in the expectation that it eventually will, tells us more about our own behaviour than the market’s.

Here are a few examples of how anchoring bias can creep in and why we can’t rely on it to make good decisions for us.

We’re all susceptible to anchoring because we’re simply not great at making decisions under pressure - and when money is involved it’s often the most pressure we put on ourselves. It’s why we need to step back and think a bit more about how healthy our approach is to investing.

Counteracting anchoring bias is more about adding a series of checks into your investment process. It means you won’t be relying on the same brain that falls foul of bias in the first place, and gives you a repeatable method to follow so you know you’re mitigating anchoring bias as much as you can. Here’s a four-step process to help you on your way.

1. Ask a new question. Instead of keeping one eye on your original buy price, try asking yourself if you would buy the same stock today at the current price. A fresh look at the opportunity set and valuation today can help detach the company from where it used to be and means you aren’t comparing apples today to oranges in the past.
2. Focus on fundamentals. How’s the business doing? Is management succeeding in using profits to generate more profits? Is debt under control? Are operating margins healthy? There’s no better preparation for shaky periods than getting to grips with the balance sheet - whatever happens in the wider world, you’ll have a good knowledge of how your company operates. It will also give you a good feeling of where the business is headed, how management plans on getting there and how much you trust that trajectory. Importantly, you’re focusing on real-world revenues, not guessing and hoping at a moving share price. If the business deteriorates, you’ll know and will have a better reason to sell than a line crossing a round number.
3. Keep a captain’s log. Whether it’s on a post-it stuck to your screen or in a lovely leatherbound journal, make a record of what you bought, why you bought it and what would make you sell (an actual scenario, not an imaginary number). It will help you see through the gyrating market charts and think about the company underneath. Keeping a reminder like this close to hand can help remind you of your original thesis and the bigger picture as opposed to today’s price swings.
4. Seek out the opposite view. Wide-eyed investors focusing on the 100x return tend to think about all the things they’ll do if they’re right on the stock. Measured investors are more likely to ask “What if I’m wrong?” If a friend, colleague or fellow investor has the opposite view to you, great. Ask them why, try to find your own blindspots and objectively reassess your position. It doesn’t mean they’re right but defending your holding with up-to-date information will prove your resolve to yourself as much as to them. You never know, if they are right, they might show you how anchored to past prices and arguments you are.

In the end, we’ll all fall victim to anchoring bias. It’s a natural part of investing but the best investors out there will recognise their emotions, fear or greed coming out and do something about it.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.