In a recent NBC news article, writer Julie Compton reviews Emily Guy Birken’s new book, End Financial Stress Now: Immediate Steps You Can Take to Improve Your Financial Outlook. She focuses specifically on the issue of anchoring.
What is Anchoring?
Anchoring is a psychological term. It’s more commonly called the anchoring bias, although sometimes it’s called the anchoring tendency. It’s the name for a form of cognitive bias that seems to be natural to our human brains. We use it, generally without our awareness, when making decisions.
Basically, our brains like to make comparisons. So, when we try to make a decision, we draw from a comparison. The anchoring bias describes the phenomenon that we tend to rely heavily on our first related reference in order to make that comparison. We especially engage in anchoring when numbers are involved.
For example, a college student is considering getting a career as an elementary school teacher. His career counselor tells him that the average starting salary is $40,000. When he graduates, he starts looking at jobs. Due to anchoring, if he gets an offer of $50,000, he’ll feel like he’s making above average.
If he did his research, he might learn that the starting salary in his city is actually $55,000. But having not done the research, he doesn’t know any better, and his anchoring bias makes him feel good despite the reality. Even after doing research, it takes effort to get the anchoring effect out of your mind.
Anchoring Bias Affects Our Money Mindset
The first bit of information that you receive in relation to any specific situation is going to become your anchor. As you can see, the anchor greatly affects how you think about money. You may be willing to spend more or less because of what you perceive is a “fair” price.
For example, I moved to San Francisco 13 years. The first few one-bedroom places I looked to rent were about $2000 per month. That’s my anchor. Despite understanding that rent rises, I find it absurd that the average one-bedroom here rents for $3700. I’m absolutely unwilling to pay that much because it’s so far outside of my anchor. However, someone who just moved here two years ago has a different anchor and may not think that’s too expensive at all.
Psychology-savvy marketers take advantage of our anchor bias all the time to get us to part with more money. They show you the most expensive option first, making that your anchor. Anything else seems cheaper by comparison, so you’re more likely to buy. For example, you visit a vineyard and they offer you a taste of a $100 bottle of wine. At the grocery store, you always buy the $15 bottle. You certainly aren’t going to buy the $100 bottle. However, that’s become your anchor for this vineyard, so you walk away with a $60 bottle and feel like you got a good deal.
Anchoring can affect your decisions related to spending, saving, earning, and investing money.
Making Anchoring Bias Work For You
Emily Guy Birken’s book explains how you don’t have to let your natural anchoring bias ruin your finances. She says that you can overrule the random whim of what you happen to be first exposed to by consciously setting your own anchors.
If you’re the aforementioned college student, research what the average starting salary truly is in your area. Better yet, set a minimum that you’re willing to accept and make that your anchor.
If you’re going to visit a new vineyard, decide in advance what the maximum amount is that you’re willing to spend on a bottle of wine. That’s your anchor. Compare all other options to that. Ignore what the people there try to sell you.
If you’re having trouble setting your own anchor, the author suggests this simple tip: Convert cost to hours. Basing everything on the amount of hours it would take you to earn that amount of money can assist you in setting your own smart anchors. For example, if you earn $20 per hour, are you willing to spend one hour earning a bottle of wine? Are you willing to spend five hours earning a bottle of wine? You set your anchor based on your hours, convert that back to the dollar amount, and that’s your financial anchor.
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