First Impressions! Anchoring! Underrated Forces Of The Universe!

I want to discuss with you a phenomenon that has applications in the investing world and beyond: anchoring. Simply put, anchoring occurs when someone tells you a fact or opinion, and then you use that information to make a series of decisions thereafter (that are based on that first bit of information).

If someone performs their own analysis and concludes that Berkshire Hathaway is worth $150 per share, the fact that the price is $115 per share at the time they perform their analysis will affect their subsequent decisions. If, say, the stock goes up to $145, they may be reluctant to buy (even though it is still $5 less than their estimate of value) simply because the twenty percent rise in the price of the stock somehow indicated that it is now expensive.

You see it all the time with people who conclude “that stock is at a 52 week high, therefore it must be expensive” or “that stock is at a 52 week low, therefore it must be cheap.” Those people are thinking in terms of price anchoring. As a value investor, this is one of the shackles that must be thrown off—something is worth the amount of future cash it will be able to generate, adjust for the likelihood that it will happen, and then judged in relation to the price at which you’d buy. That’s why someone buying Colgate-Palmolive at “52 week highs” for forty years straight ends up getting rich, whereas someone thinking they are value investing buy purchasing General Motors (before the bankruptcy) at the 52 week lows doesn’t end up in nearly the same position.

Price anchoring is most often used in negotiations, the most common of which would be car purchases. The person who makes the first offer is going to have a lot of sway over the final price paid. The tendency is for the anchored price to disproportionately influence for the final price actually paid at the end of the negotiation. If you found a bunch of used cars that generally go for $10,000 in a person-to-person interaction (I’m not including car dealerships because there are models at play there that override anchoring), the buyer that suggests a $5,000 offer price first is probably going to get a better deal than the seller that suggests a $15,000 price first. The first mover tends to determine the subsequent tone, pace, and wiggle room of the dealings thereafter.

Heck, psychologists have even recently begun studying the effects of “people anchoring” in which an introductory sentence place an anchor that determines the results you might get. Let’s say you need a second day off in a month, and your office policy is to only get one day off per month. If you just go and ask your boss for that day off, who knows what might happen.

If you walk in and anchor your conversation with, “Mr. Smith, I know you’re someone who understands that rules need to be followed and that is what separates us from the competition, but I was really hoping to get this Friday off even though I was off last Friday as well…” Someone who does that ain’t gonna get Friday off.

On the other hand, if you start the conversation by saying, “Mr. Smith, I know you have a reputation for using common sense, especially when it means taking care of employees, and being fair”, then you are going to get a much better result. It all has to do with how you anchored the position and perspective of the conversation.

In some situations, it can even protect you from harm. I recently watched this video of Dena Simmons, who was on the verge of being attacked by a student with scissors in the classroom. How did she solve the situation? By saying: “Justin, I know you’re a kind person, and you wouldn’t harm me.” Once you stylize someone in a complimentary way, it sets a powerful anchoring precedent for them to want to prove themselves worthy of the claim you bestowed.

Originally posted 2014-02-16 17:02:04.

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