Money Behavioral Mistake #5. Anchoring

Anchoring. Young playful woman with big hat and sunglasses having fun on the yacht. Happy summer vacation. Top view with wide angle
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Vision is the art of seeing what is invisible to others.

Jonathan Swift

Anchoring refers to the tendency to hold to certain beliefs even when faced with new information that should alter those beliefs, thereby creating, in effect, tunnel vision.

In other words, people start at an initial mental reference point based on past experience. This might lead to overweighting irrelevant past data or slowly adjusting to a correct answer or decision as they receive additional information.

People start at an initial mental reference point based on past experiences.

Anchoring. Stylish wealthy friends having fun on a luxury yacht

As applied to the announcement of a company’s earnings, anchoring results in security analysts under-reacting to unexpected earnings announcements. This does not mean there is not a reaction, because such announcements typically move the stock quickly and, in some cases, significantly. It does mean that security analysts do not revise their earnings estimates enough to reflect this new information. As a result, positive or negative earnings surprises tend to be followed by more positive or negative earnings surprises.

It does mean that security analysts do not revise their earning estimates enough to reflect this new information.

Individual investors, of course, also experience anchoring.

Achoring. woman-standing-beside-shore-holding-mirror-on-her-back

Their investment experiences create beliefs that they subsequently rely on, and then they under-react to new information. One of most vivid examples of this can be seen by examining investor conduct with technology stocks in the late 1990s. It appeared that investors could do no wrong by buying technology stocks and, no matter what prices were paid, technology stock prices would be higher in the future. However, even though valuations went to extremes and it became evident that the prospect of any earnings for many of these companies was well in the future, if ever, many investors did not react to this information. By the end of 2002, the cost of anchoring to these stocks’ prices was obvious.

Related to anchoring is the Normalcy Bias.

Which is essentially the refusal to plan for, or react to, a major event (often negative) that has never happened before. People may put blinders on because of the normalcy bias, and not want to acknowledge, much less react to, events that could be real game changers.

People may put blinders on because of the normalcy bias, and not want to acknowledge, much less react to, events that could be real game changers.

Next. Read about Money Behavioral Mistake #4. Hindsight Bias.

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