Anchoring

What is 'Anchoring'

Anchoring is the use of irrelevant information as a reference for evaluating or estimating some unknown value or information. When anchoring, people base decisions or estimates on events or values known to them, even though these facts may have no bearing on the actual event or value.

BREAKING DOWN 'Anchoring'

Here's an everyday example: a friend asks how much you pay in rent for your 800-square-foot apartment, and then asks how much a 1,100-sq-ft apartment would cost to rent in the same building. Would you make an estimate by adding a little more to what you pay even if you've no idea of the actual costs? If so, you would be anchoring your estimate onto what you pay for your apartment.

In the context of investing, investors will tend to hang on to losing investments by waiting for the investment to break even at the price at which it was purchased. Thus, they anchor the value of their investment to the value it once had, and instead of selling it to realize the loss, they take on greater risk by holding it in the hopes it will go back up to its purchase price.

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