Keeping an eye out for anchoring bias
As human beings we suffer from numerous cognitive biases, things that make us think in certain ways that are for the most part not helpful. One that hits investors especially hard is the anchoring bias.
Anchoring bias is the result of us as humans relying too heavily on the first piece of information that we get when making a decision – in other words, the first impression. This can happen when you meet a new person or when you first see a house you’re potentially looking to buy. If the first impression of the house is negative it will take a lot to convince you to buy, whereas if it’s positive, the agent will hardly have to do any work as you’ll be hooked. The problem is that information we receive after that f irst impression may be critically important, but we dismiss it as less important.
When investing, that anchoring typically involves the price of a share; either the price paid or a price we remember. Often, the price we remember is when we first saw the stock.
For example, I remember putting an offer in to buy Naspers* at R248.50. The offer was R250 and I never got the stock. Now, with Naspers at around R2 000, I still have that R248.50 imprinted in my mind and struggle to move on from it. It’s not just that I missed a great investment, it is also that I still think Naspers is a buy at R248.50 and struggle to adjust the new valuation of some R2 000.
The other side of this is when a stock has fallen and we are anchored on the higher price. Here Kumba is an example. A reader emailed me to say that they’d been watching Kumba slide from around R500, so surely now it is a buy at around R130? The issue is that the R500 price point is totally meaningless. It is a random fact that the reader remembers the R500, what matters now is the prospects for Kumba going forward.
Further, we tend to believe that a stock will get back to the price we remember, so if R500 is the ‘target’ it must be a steal at R130. This is just not reality and many ANCHORING BIAS IS THE RESULT OF US AS HUMANS