This spring my husband and I were at Goodwill and saw a kitchen cart for $25 that I really liked. We were in a hurry and weren’t sure if it would fit in our kitchen, so we passed it up. Throughout the day I kept thinking of all the different things I could do with it: set herbs on it, organize all the miscellaneous small appliances taking up room on my counter or in my cupboards, and if it didn’t fit I could put it in the garage and use it as a planting station! All of a sudden I had to have it. At my first chance Monday I went back to Goodwill, and of course, it was gone. I was devastated. I actually felt a true sense of loss. My husband, being the thoughtful husband he is, found the exact cart at Ikea. I was elated! Until I saw the price: $109! However, at Goodwill it was only $25. All of a sudden, I couldn’t picture that cart bringing me as much “happiness” as the one at Goodwill would have. In fact, I soured on the whole thing. What happened?
Anchoring Bias: What Is It?
Anchoring is both a behavioral economics and cognitive psychology term. It relates to the idea that we have a bias towards the first bit of information we receive. It’s like a short-cut in the decision-making process. The first time I saw the kitchen cart, the price was $25 so my brain anchored to that price. Sure, I knew it was at a second-hand store and if I could find it new it would be more, but it was too late. I was already attached to the $25 price. Even though I want that cart and it would be useful, I am just unwilling to pay more than $25 for it. In this case, anchoring bias helped me avoid spending more on something.
Of course, anchoring can also work against us in the decision making process. Take another example: we all have heard the diamond engagement ring commercials that state that we should spend the equivalent of two month’s salary on that ring. Anything less, must mean you don’t love your fiancé all that much. Right? Wrong! The right answer is to spend how much you can reasonably afford, preferably without going into debt. How much you spend on an engagement ring has nothing to do with your commitment, nor does it guarantee your marriage will last. Sound financial decisions just may, though!
Anchoring can Influence Your Salary Negotiation
Anchoring is incredibly powerful. Not only can it influence how much we are willing to pay for something, it can influence all sorts of decisions from what age your child should get their first cell phone, to how old we think we may be when we die, to how successfully we negotiate our salary.
Here’s a tip: next time you ask your boss for a raise, besides making a solid argument for why you have earned that raise, it can’t hurt to ask for a higher amount than you think you will really get. Why? Because whoever makes the first offer has set the bar, and research shows that it will bias the negotiations in your favor.
Good Decision-Making Skills Will Help You Combat Anchoring
Now that you know about the concept of anchoring, stay aware to use it to your advantage. Let’s think about buying a car for minute. If you discover the average price of the car you want, with all the features you want is $30,000 and the first dealer you go to offers you the car for $29,000 you may think you’re getting a good deal and go ahead and purchase it. What you would never find out in that scenario is that the dealer across town is selling the same vehicle with all the same features for $26,500 – you could have saved $3,500 on that car!
Follow these tips to help you combat anchoring and save money:
- Employ Due Diligence
With the car example above, due diligence entails researching several different dealers in your area to find the best price on your dream vehicle. This also applies to hiring contractors for home repairs or getting quotes on a car repair.
- Establish a Range
This can come from online research, by talking with different dealers or getting bids from different companies. Kelly Blue Book or NADA Guides are great places to get a range on the cost of a new or used vehicle. If you’re negotiating your salary you may want to use a salary calculator, talk to a recruiter in your area, or talk to others in the industry.
- Determine What You Can Afford
Set your own anchor by deciding what your budget is before you even look at buying something or entering into a negotiation. If you have to borrow to buy it, how much debt are you willing to go into? What will the monthly payment be and how will that affect your other purchases? On the other hand, can you save for it instead?
Understanding anchoring may not make the world around us any less expensive, but it is powerful to understand when making any decision. I used it without even knowing it and it saved me $109! Think how much you could save, or earn!
Author Shannon Doyle is an LSS Financial Counselor.