Value Investing In Your Car Episode 6 – The Power Of Anchoring Bias
In Episode 1 of Value Investing In Your Car, I answered the question Does Value Investing Work Anywhere In The World?
In Episode 2, I answered the question When Does Value Investing Work Best?
In Episode 3, I told you about the best book I read in 2017, and recommended some other great books that I read in 2017.
Get our Guide 7 Tips to Picking Great Stocks and 3 Times You Must Sell for free to make better investment decisions today.
And in Episode 4, I talked about how my family inspires me to become great and how having someone or something inspire you can change your entire life.
In Episode 5, I talked about how I may have found a new investment for the first time in almost 3 years.
And today in Episode 6, we’re talking about Anchoring Bias, its immense power, and how this relates to value investing.
So what is anchoring bias?
Anchoring Bias – A Major Cognitive Bias And Mental Model
Above is the generally known definition for anchoring bias… I would change one minor thing about the above – this change is in bold.
I would change it to this – “Anchoring or focalism is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered or the piece of information that best fits what they want. Even if it’s not reality.”
Why?
In the 10 minute video below, I describe a real-world example about how I struggle with anchoring bias and gas. What I do about this bias, and how understanding the mental model of anchoring bias and what to do about it can help you become a better value investor.
I talk about a real – world example in the video above but a value investment example would be…
Let’s say you found a small cap investment that is undervalued and that it’s worth $25 per share, so you decide to buy its shares at $20 while you can.
Instead of going up though, the stock price drops to $10 a share – or a 50% drop – 6 months later based on some very short – term problems for the company.
After reanalyzing the company to see if you made a mistake, you find out that these problems haven’t changed the economics or profitability of the company at all. And have done nothing to harm the long – term health of the company’s operations or balance sheet.
Should you buy more, do nothing, or sell your stock?
If you let anchoring bias get in the way – and your emotions take over – you may make the decision to sell because of these short – term problems.
Even if you should hold on – or even maybe buy more shares – since the company is the same or better off now, than it was when you first bought.
Knowing what anchoring bias is and how to potentially deal with these emotions and cognitive biases are part of the battle when you come across this example yourself after you buy an investment.
Some of the other stuff talked about in this video…
- Why understanding Anchoring Bias is so important for value investing
- Why understanding other cognitive biases and mental models are important to become a great value investor as well
- How I still struggle with anchoring bias every time I gas up my truck
- What I do about this
- How I fight against this and other biases
- And more
I’d love to hear your thoughts on anchoring bias in the comments below.
Here’s another post on Medium about anchoring bias if you want to learn more.
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