Anchoring is a cognitive bias that describes a reasoning flaw, of relying heavily on an initial piece of information (the anchor).
Subsequent decision making and judgements are made with a bias towards interpreting other information around the anchor.
Why does it matter?
This bias can result in investors making poor investment decisions. A pessimistic market forecast could lead an investor to make defensive investment decisions, even when other forecasts are more positive.
The investor is anchored to the initial forecast and makes decisions around this anchor point.
Another example is stock price anchoring. An investor purchases shares at £100 per share, and continues to hold on to the shares when their valuation falls. The investor is anchored to £100 even when evidence may suggest a revaluation is warranted.
Help clients overcome this
Explain how cognitive biases can influence peoples decision making, and affect investment outcomes. Discuss the importance of long term investment goals which should always be the focus when making investment decisions.
This will then help you to;
- Educate investors on the anchor bias.
- Explain that investment decisions should always be based on a broad range of evidence.
- Demonstrate that a well diversified portfolio can guard against knee jerk reactions in times of market volatility.
- Remind the investor of their investment goals, which can help avoid decisions being made on the first piece of information they see.
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The information in this document does not constitute advice or a recommendation and is for the information of the recipient only. Past performance is not a reliable indicator of future returns. The value of investments and the income derived from them can go down as well as up and you may not get back the amount invested. PK Wealth Ltd and PK Financial Planning LLP are authorised and regulated by the Financial Conduct Authority.
This content was originally published by EBI. Please visit EBI’s website for more information.