In this month’s edition of “Money Matters,” Scott talks about anchoring, the concept of making decisions based on a previous thought or feeling that may not be relevant at the present time. Scott discusses how anchoring can have a negative effect on your finances and why investors should be aware of why they are choosing to make a certain decision.

Money Matters: Financial Decision-Making and the Anchoring Effect Transcript

0:00:00.0 Anna: WTIP is pleased to bring you another edition of Money Matters. It's a monthly feature intended to help us understand more about managing our finances. Scott Oeth is a certified financial planner and adjunct professor. He works with many individuals and has taught retirement planning and wealth management strategies to hundreds of financial professionals. Scott joins us now by phone. Good morning, Scott.

0:00:22.8 Scott Oeth: Good morning.

0:00:23.9 Anna: Thank you for being here.

0:00:27.5 SO: Absolutely.

0:00:27.6 Anna: So, you proposed an interesting sounding concept to me yesterday about this. You wanted to discuss the concept of anchoring as it affects somebody's financial decision-making. Can you explain what anchoring is?

0:00:41.7 SO: Yeah, absolutely. Let's talk about this. I do want to throw it out first, any time we're discussing financial matters, my compliance team always wants me to remind listeners to do their own research and seek their own expert advice, but that said, anchoring is really interesting. Anchoring is a very powerful and very pervasive noted psychological phenomenon in the field of behavioral finance, it has to do with people's tendency to develop answers or hinge decision points based on a piece of earlier information, and sometimes something that's really not relevant to the decision at hand. One example I thought was pretty interesting, Dan Ariely, who is a noted expert in this field, he ran an experiment where he'd ask people for the last two digits of their Social Security Number.

0:01:29.7 SO: Now, this is a completely random number, the last two digits, and then he'd put a bottle of wine in front of them—same bottle of wine for all the people in the study, and guess what. On average, those whose last two digits were higher numbers tended to say they'd be much more willing to pay much more for the same bottle of wine. So, unrelated but a number was put into their mind and drawn forth its last two digits, and then they're shown a bottle of wine and asked how much they would pay, and the numbers were dramatically higher [for people with higher social security digits]. So, this comes into play many, many ways in our daily lives and our financial decisions. It's kind of used against us in sales both in pricing psychology and the volume of things that are being sold that's basically around investments.

0:02:16.1 SO: I think today it's very common. You might look at an investment that's much cheaper than it was a year ago, and say, "Ah, it's a great deal," because you're looking at the price it was a year ago, but there might be some real fundamental reasons why that investment has gone down in value, and just because it's cheaper doesn't necessarily mean it's a great deal. One real interesting one, I was just having a conversation with an investor recently who was holding a technology stock and mentioned that it had taken a serious hit. They wanted to sell it, but they really wanted it to get back to break even before they would sell it.

0:02:53.5 Anna: Interesting. So, does this affect people's willingness to, like, for instance, if they bought a stock, I'm just making this up, $20 and it has dropped now to 12, they want to hang on to it until it gets back to that magic number?

0:03:09.4 SO: Yeah, there can be a number of factors that play on. Sometimes there's things like tax considerations that come into play or whatever, and there's another noted behavioral finance heuristic, they're called loss aversion, which people don't want to admit they made a mistake, and they might feel like by selling at 12 when they bought it at 20, they're admitting they made a mistake. But I think this concept of anchoring is very strong, in that case, Anna, where I bought it at 20, I just want to get back to break even. When today, you should look at the current information that is out there and try to make a good decision. The $20 that was paid six months ago or a year ago or five years ago, it's really irrelevant at this point, but it's very common to get fixed on that.

0:03:54.6 SO: So, a simple test I like to use, or an exercise, is we look at it and say, "Okay, maybe you bought $1000 worth of that stock or something, if you had that same amount of cash would you buy $1000 worth today?” Sometimes this helps to try and clean the slate and create zero-based thinking and say, “Let's look at the information and the facts as they are today, and see if we'd come to the same decision, rather than feeling this endowment that's being tied to the past decision.” And another thing, of course, I think it's useful is get qualified outside expert advice, someone who is not emotionally attached to that decision point to then come in without those emotional factors that really influence the decision.

0:04:46.8 Anna: Yeah, when you explain this concept to your clients, do they usually grasp it and are willing to change their behavior or do you get a lot of push back or what do you see?

0:05:00.9 SO: Well, what I find is, first of all, I'm a financial advisor, and I study this a lot. I'm not a psychologist or a psychiatrist or anything like that, but there is certainly a coaching element, and I think creating an awareness and just trying to really create an open thinking environment is helpful and sometimes these factors are very strong. I see incredible emotional attachments if there is something that was inherited, like a piece of farmland from a grandfather or a parent, or maybe an investment that dad had chosen, or mom worked for this company for all these years. So, there's certainly times like that where there's very, very strong emotional attachments to financial decisions, and I think it does help to... I'm not necessarily trying to diagnose and say this is what you're doing, but we're creating awareness and trying to think it through, and say, we'll try and encourage and say, "Let's look at the situation today, and let's look at your situation. Does this make sense for you and what you're trying to do with your financial goals?"

0:06:12.5 Anna: Sure, okay. So, we know to be aware of the anchoring bias. What other money-related things should we be thinking about right now?

0:06:21.6 SO: Well, there's one thing I wanted to point out. I tend to talk quite a bit about the stock market investing there, but something that's happening now as part of the fight against inflation: interest rates are being pushed up. This is an attempt to effectively put the brakes on the rise of prices to make it more costly to spend borrowed money, and the flip side is to make it more attractive to park money in interest-bearing accounts. That's what's changing life, where I would encourage people to take a look, and again, do your own research and get your own advice, but things like money market accounts, certificates of deposit, and certainly in the bond market and there's those... The bond market is generally viewed as more safe and stable investments, but there is some risk there. There's volatility; prices can go down. We've seen that this year, but it's time to reevaluate all those things because for the longest time, interest rates were very, very low, and there was not much difference. There wasn't a lot of exciting stuff to talk about, but now shop where you're parking your cash in the different types of money market holdings or certificates of deposits because with rising interest rates the rate that you can earn on your safe money is really going up.

0:07:37.4 Anna: Okay. Well, that's great. Thank you. That's good information. I was talking with Scott Oeth. We're talking finances with him on the first Wednesday of the month here on North Shore Morning. Is there anything else you'd like to add?

0:07:50.0 SO: I just really enjoyed the conversation and appreciate the time.

0:07:52.7 Anna: Okay, thank you so much, Scott. Thanks for talking with us. Talk to you next month.