What Do Anchoring and Modification Mean?
A phenomenon known as “anchoring and adjustment” occurs when someone rests their first thoughts and responses on one piece of information and then adjusts as a result of that starting point. The anchoring and adjustment heuristic covers situations in which a person starts with a certain objective number or value, known as an anchor, and then modifies that information over time until an acceptable value is attained. When the anchor vastly differs from the correct answer, changes are frequently insufficient and stick too closely to the original anchor.
Understanding Adjustment and Anchoring
Behavioral finance defines anchoring as a cognitive bias in which people focus on a specific number or value—typically, the first one they receive, such as an estimated price or economic prediction. An individual experiences anchoring when they base new judgments on the old anchor number, as opposed to the conservative bias, which has comparable effects but is based on how investors compare new information to previous information. Giving new information careful thought to assess its implications on the initial forecast or judgment may assist in lessening the consequences of anchoring and adjustment. Still, the decision-maker’s personality traits are just as crucial as deliberate deliberation.
The issue with anchoring and adjustment is that all subsequent adjustments will be systematically skewed toward the anchor and away from the genuine value if the value of the first anchor is not the true value. However, there is no issue if the anchor is near the genuine value.
One problem with modifications is that they might be swayed by unrelated information that the person is contemplating and making erroneous links to the real goal value. Consider the scenario when a person is presented with a random number and then asked a question unrelated to the random number that asks for an estimate or prompts them to solve a mathematical problem. The random number they were presented may be interpreted as a visual signal and act as an anchor for their replies, even if it has nothing to do with the solution. Anchor values may be created by the user, produced by a pricing model or forecasting tool, or proposed by a third party.
Even when people are made aware of and try to prevent it, studies have shown that some circumstances can impact anchoring. Experimental studies have shown that educating individuals about anchoring, warning them that it might skew their judgment, and even providing them with financial incentives to refrain from anchoring can lessen but not completely eradicate the effect of anchoring.
Higher expertise and experience in a particular topic might lessen the effects of anchoring in that subject area. In comparison, higher levels of general cognitive capacity may lessen the effects of anchoring more broadly. Additionally, personality and mood might be important. As well as increasing anchoring, agreeableness, conscientiousness, introversion, and openness are positive personality qualities.
Financial and Business Anchoring and Adjustment
An effective tool in sales, pricing, and pay negotiations is anchoring and adjustment. According to studies, establishing an anchor at the beginning of a negotiation might impact the result more than the subsequent negotiating process. The range of all future counteroffers may change due to a planned beginning point.
For instance, a used vehicle seller (or any salesperson) can start discussions with a price that is arguably far higher than the fair value. The ultimate price will typically be greater than it would be if the vehicle salesperson had started with a fair or reasonable price since the high price acts as an anchor. When a recruiting manager or potential employee suggests an opening wage, a similar strategy may be used throughout the hiring process. The conversation may then be pushed back to that initial position by either party to arrive at an acceptable sum derived from the anchor.
An analyst in finance may use the results of a pricing model or a tool for economic forecasting as their anchor. Examining several models or lines of evidence might be one approach to combat this. According to social psychology researcher Phillip Tetlock, forecasters who base their predictions on a variety of viewpoints or concepts (referred to as “foxes”) tend to be more accurate than forecasters who concentrate just on one model or a small number of major ideas (referred to as “hedgehogs”).
An analyst’s work may be less susceptible to anchoring effects if they consider various models and projections.
- A person uses the cognitive heuristic of “anchoring and adjustment,” whereby they begin with a basic notion and then modify their views in light of this notion.
- When the original anchor deviates from the genuine value, it has been demonstrated that anchoring and adjustment would yield incorrect results.
- The consequences of anchoring can be altered by awareness of anchoring, financial incentives, and carefully considering various potential ideas, knowledge, experience, personality, and mood.
- In pricing and sales negotiations, anchoring may be leveraged to your advantage by establishing an initial anchor that will impact later discussions in your favor.