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January 2023

Anchors Aweigh!

“How Anchoring Bias Can Sink Your Investment Strategy.”


Written by
 
Phillip D. Beckner, CFA, CAIA

Portfolio Manager

The ups and downs of the stock market can take a toll on even the most seasoned investor. Add in the influence of cognitive or behavioral biases, and it’s no wonder we sometimes make less-than-optimal investment decisions. One of the most common biases investors must contend with is anchoring. This refers to the tendency to attach undue importance to initial data points when making decisions and to make insufficient adjustments based on new information.

Investors often encounter this bias when contemplating stock prices. For example, an investor viewing the 2022 chart of Company XYZ shown here may conclude the stock is undervalued based on its starting point and refuse to sell until the price recovers. New information, such as a recent decline in the company’s earnings, should alter the investor’s analysis, but anchoring bias may lead the investor to dismiss that information and fixate only on the stock’s beginning value.

Anchoring bias can also influence the analysis of a company’s results. If company A has grown earnings 20% on average over the last few years, anchoring bias may lead an investor to believe this pace of growth is likely to continue, despite new evidence to the contrary. On the other hand, if company B has historically struggled to grow but reports changes to operations that could drive future earnings growth, this same investor may dismiss the new announcement. In both cases, if the investor remains anchored at their initial growth rate assumptions and fails to incorporate the new information, their estimates for forward earnings—and ultimately the company’s prospects as an investment—will be biased.

To counteract anchoring, investors should always ask themselves whether initial data points are having an undue influence on their decisions and should strive to treat all information objectively. That’s certainly easier said than done, but well worth the effort.