Key Takeaways
Too many investors fixate on a specific round number such as a stock price or 401(k) balance instead of on their long-term goals.
Instead of anchoring to a random number of shares or a price point, be disciplined in your investment approach and reap the benefits of higher returns over time.
Anchoring can lead to poor decisions such as holding on to an investment for too long, retiring too early, working too late in life, or paying too much in taxes.
An important part of wealth management is recognizing and addressing behavioral biases. Biases can prevent you from growing your wealth and meeting your financial and/or life goals. Understanding how to manage your behavior is an effective way to improve the performance of your investments. I’ve written about other behavior biases in previous blog posts, but today I’d like to discuss “Anchoring” and how it can cloud your decision-making when it comes to investing.
Anchoring occurs when investors fixate on specific reference points such as the purchase price of an asset or some other randomly chosen marker. Oftentimes anchoring centers on a round number that resonates for one reason or another. For instance, investors tell themselves “I’ll retire once I have $10 million socked away” or “I’ll sell that investment once it reaches $150 per share” or “I’ll rebalance my portfolio when the Dow gets back above 35,000.”
The danger of anchoring is that investors may resist adjusting their strategy based on new information, leading to poor decisions such as:
Holding on to an investment for too long and not locking in gains.
Retiring too early or working longer than needed.
Paying too much in taxes.
Most investors have a “favorite” investment within their portfolio. This “star performer” did well in the past and owners are reluctant to sell at any price. They will tell themselves: “I don’t want to sell until the price hits $150 per share” or some other arbitrary number they choose. The target sale price is rarely based on any information about the stock or its underlying financial metrics.
The best investors are unemotional when it comes to buying or selling. When investments perform well, they sell a portion and take a profit. When an investment is not performing well, they use it as an opportunity to purchase more shares at a lower price. Instead of anchoring to a random number of shares or a price point, be disciplined in your investment approach and reap the benefits of higher returns over time.
This same discipline also applies to tax trading. Some investors hold their investment too long because they are waiting for it to reach (or return to) some randomly chosen price. Doing so can cause you to miss out on opportunities to lower your tax bill.
Another common example of anchoring is having a fixed dollar amount in mind for retirement savings. It reminds me of those TV commercials from the early 2000s (What’s Your Number?) as though reaching a certain number estimated early in one’s working life guarantees a golden retirement decades later. People's goals change. People's standard of living changes as they reach their peak earning capacity. The number they've had in their mind their entire working lives (say $10 million) might be way too much (or too little) for what they really need to retire. Blindly chasing that number can also lead people to make suboptimal decisions such as retiring too early or working too long.
People generally underestimate their retirement spending needs (and how long they’ll live). They end up anchoring to a retirement number that’s too small (given their lifestyle) and take their foot off the accelerator when they should keep building assets. That’s especially true from an inflation standpoint. Forty years ago, you and your spouse might have had a very aspirational number in mind, say $5 million. You’d tell each other you could ride off into the sunset someday once you hit that number. It’s still a nice amount of money to have, but for some couples, it's not enough given what their desires are financially.
Real-World Example
Our firm works with a couple who were in their early 60s when they first came to see us. They had enough accumulated savings to retire based on their financial plan. However, a good chunk of that nest egg was concentrated in their company stock. They were reluctant to sell shares because the stock had recently dipped due to the recession we were in, and they were anchoring to the stock’s recent high of $100 per share. There was no fundamental reason for targeting $100. However, refusing to sell some shares at the current market price was putting their retirement plan in jeopardy. We eventually convinced them to do a staged sale based on preset prices, consistent with what was needed based on their financial plan. When the stock started to drop, we didn’t continue to hold and wait for it to recover. Had we done so, it would have taken over 20 years! Instead, we sold some shares, diversified their risk, and secured their retirement plan.
Conclusion
Anchoring is a cognitive, emotional mindset that can prevent you from making sound money decisions. Recognizing your own faulty decision-making is a great first step toward avoidance. Investing can be challenging because of the emotions involved. That’s one of the main benefits of working with an objective wealth advisor who always has your best interests in mind. We can recognize any bias you are exhibiting and make recommendations to help grow your wealth. If you or someone close to you has questions about improving your investment strategy, please don’t hesitate to reach out. We are happy to help.
RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth