Equity investing: How to avoid anchoring bias when investing

So, anchoring bias could influence your investment patterns and lead you to make sub-optimal decisions regarding your investment portfolio.

By P Saravanan and Abhishek Totawar
During the last one year of Covid-19, the equity market attracted the attention of retail investors across the globe and India is no exception. One can attribute many reasons such as declining interest rates, volatility in fixed income instruments, enhanced awareness about investment options, ease of app-based trading, etc. Often investors are their own worst enemy because of psychological biases such as greed and fear that can influence investment decisions. Let us discuss one such bias— anchoring— and find out the ways and means to avoid the same while investing.

What is anchoring bias?
Anchoring bias indicates that an investor makes decisions based on the initial information or relies too much on the recent information that he / she obtained. In other words, the concept of anchoring draws on the tendency to attach or anchor investor thoughts to a reference point or information which might have no logical relevance to the investment decision at hand. Generally, such bias occurs when an investor pays attention to unwarranted details, which lead to error in investment decisions. So, anchoring bias could influence your investment patterns and lead you to make sub-optimal decisions regarding your investment portfolio.

For example, while selecting a share, often investors check the 52-week high or low price. So, this initial information which registers in their mind is the anchor. Investors adjust the anchor price up or down, according to the information which they acquire further. In fact, the 52-week high price is an irrelevant number and often misleading. Because, compared to that price, the current market price may look cheaper, but still the share could be overvalued.

How to avoid anchoring bias?
It is advisable for investors to practise critical thinking to avoid anchoring bias. Critical thinking in this context means that when everyone around you is getting all positive news about a share or industry, you must try to find out negative points in it as well. Such thinking will provide investors a broader view of the entire scenario.

Similarly, analyst forecast /expert opinion about any particular industry or company makes investors anchored to their information, which may not be correct. In such scenarios one should do a thorough research on their own before investing their hard-earned money. Similarly, when the price of the shares in your portfolio goes up or down, to avoid price anchoring, you must check the company fundamentals before making a call to sell or buy.

The easiest way to overcome the anchoring bias is to track one’s behaviour and identify the anchors that you are normally prone to be dragged down by. Objectivity and a practical approach to investing can go a long way in helping you to be away from anchors that influence your investment pattern and thus affect your portfolio returns negatively. By means of practice and over a period of time, one might get better at avoiding this investment bias.

To conclude, once when good habits are formed, getting anchored to the reference point will be eliminated. Further, one can overcome anchoring bias with logical thinking, due diligence and a practical approach driven by research and not by emotions.

The writers are faculty members in IIM Tiruchirappalli

• Anchoring bias
  Anchoring bias indicates an investor makes decisions based on the initial information or relies too much on recent information that he obtained
  It is advisable for investors to practice critical thinking to avoid anchoring bias
  The easiest way to overcome the anchoring bias is to track one’s own behaviour and identify the anchors that you are normally prone to be dragged down by
  Once good habits are formed, getting anchored to the reference point will be eliminated