Behavioural finance - When numbers count: 12/31/23 = 123 123!
The year 2023 ended on a fun note thanks to some eye-catching numbers. Did you notice that the last date of the year — at least in the American format — was 12/31/23, i.e. 123 123? With 2023 behind us, we take a look at how figures— and especially past figures or “anchors” — can influence our financial decisions.
Social security number vs. bank card number
Just a few weeks ago, many of us were still in and out of shops buying Christmas gifts and supplies. A study conducted in 2003(1) asked students to estimate the price of ordinary consumer products (computer accessories, bottles of wine, luxury chocolates, and books). The first question they were asked set out to assess their willingness to buy the products (without knowing the market value) for a dollar figure equal to the last two digits of their social security number. For the second question, the students were asked the maximum price they would be willing to pay for each product. It emerged that students with above-median social security numbers agreed to a market value 57% to 107% higher than that agreed to by students with below-median social security numbers. Even more striking, was that there was a factor difference of 3 between the quartile of students with the highest social security numbers and the quartile of students with the lowest social security numbers. Depending on the quartile, the price of a bottle wine, for example, ranged between $8.64 and $27.91!
The experiment perfectly illustrates what is known as the “anchoring effect”: the tendency to take a reference value, or “anchor”, into account when making an estimate. Research has also demonstrated the existence of this bias in real estate. A paper published in 1987(2) highlights the influence of the level of the listing price (higher or lower than the true value) on the independent estimates made by a sample of real estate experts and students. Both groups’ estimates were biased, with gaps of between 11% and 14% between the experts and the students (depending on the listing price).
The anchoring bias can influence our behaviour in more adverse and unexpected ways, sometimes with very long-lasting consequences. More recent research(3) carried out on data from 2015 to 2020 demonstrates that an investor’s first investment on the stock market conditions subsequent investments quite significantly, and for many years.
Multiple anchors to account for unrealised capital loss, economic scenarios, and market updates
The anchoring bias has a major influence on how we manage our personal finances, and in more than one way.
First, it could delay the selling off of assets with unrealised capital loss. The initial investment amount (or entry value) acts as an anchor, below which it is hard to sell! The anchor can include an entry price (i.e. the level at which unrealised capital losses can be erased), as well as the historical average value of the asset since the time of the investment. It can also include the record peak since the time of investment (maximum share price, for instance). By refusing to sell an asset, the investor overlooks other investment vehicles which may offer better prospects. Rather than latching onto these anchors, and for the wrong reasons, we must break free of them and not let opportunities pass us by.
Second, and in the interest of keeping abreast with current events, bear in mind that conventional economic assumptions can also be anchors likely to affect our decision-making. Thinking about asset allocation in terms of zero inflation and low-to-negative interest rates will lead to less than optimal decisions, as we have not fully grasped our new economic environment. In other words, we must distance ourselves from conventional thinking that dictates that a low gross yield could still be a source of growth net of inflation words —quite possibly a challenge we currently face. Instead, we need to adjust the risk/return ratio just as quickly as conditions on the market change.
Finally, the anchoring bias goes beyond numbers. It is that first impression we struggle to move away from by, for example, giving due consideration to new information. Its impact on financial management is significant: it reduces our ability to change our thinking on an investment or asset allocation, even in the event of overwhelmingly positive or negative news.
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On a final note, next time you go shopping… avoid looking at your social security number!
(1) "Coherent Arbitrariness": Stable Demand Curves Without Stable Preferences”, G. Loewenstein, D. Ariely, D. Prelec, 2003
(2) “Experts, Amateurs, and Real Estate: An Anchoring-and Adjustment Perspective on Property Pricing Decisions”, G. Northcraft et M. Neale
tzkowitz, Jennifer; Itzkowitz, Jesse; Schwartz, Andrew (2023). "Start Small and Stay Small: Anchoring in App-Based Investing". T
(3) “Start Small and Stay Small: Anchoring in App-Based Investing”, Jennifer Itzkowitz, Jesse Itzkowitz, A. Schwartz, 2023
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