It is important to concentrate on real issues while making financial decisions.
"My flat is much better than the one Sharma sold for Rs 50 lakhs (Rs 5 million). I should get at least Rs 55 lakh (Rs 5.5 million)," declared Sheetal Kulkarni. Recently, Kulkani was offered Rs 48 lakhs (Rs 4.8 million) for her flat but she wanted more as she strongly believed that her flat was much better than Sharma's and it should fetch a higher price. This is a classic phenomenon that happens when you either sell real estate or buy real estate. The buyer and the seller are generally anchored at a price.
Anchoring is one of the most difficult phenomena in behavioural finance to overcome. It is a term used to explain how we often hold on to some fact or figure and use it as a reference point to make future decisions. Like Kulkarni in the above case just decided that her flat deserved more than Sharma's Rs 50-lakh flat.
Finally, after several months of waiting when the flat was sold, it fetched only Rs 45 lakh (Rs 4.5 million). Similar things can happen on the upside in a hot real estate market where you anchor your buying price to what your friend has paid for his own flat. As a result, you keep waiting for the right deal. And meanwhile, the prices keep going up and you might end up paying much more than what would suit your pocket.
This behaviour can have a powerful impact on your finances as most of the times we don't even realise that anchoring has been adversely impacting our lives. But it is especially dangerous when it comes to financial decisions. Prefer to buy mutual fund investments at Rs 10 net asset value (NAV).
You might be afflicted with anchoring if you:
Look at the Sensex to make decisions on whether to exit a stock or mutual fund.
Buy insurance based on the premium that you can afford to pay or on the basis of what others have bought.
Look at the past performance of investments before making decisions. That is, If you have received 30 per cent in the last four years, you are now mentally anchored on to 30 per cent and you might feel that, by if you lowering your expectations to 25 per cent, you are actually doing the fund or stock a favour. And this is in spite of the fact that the company's earnings growth could be between 18 to 20 per cent.
Are loyal to certain brands for reasons which might not be relevant at all.
Tend to hold on to a number, such as your purchase price of a stock, real estate or an equity mutual fund to sell the investment. The logic goes likes this. I have paid Rs 30 lakhs (Rs 3 million) and I should at least get Rs 30 lakhs from this investment.
Do things just because others in the peer group or family are doing so. Like buying a certain brand of television or a stock or an insurance plan just because your favourite neighbour has it.
In other words, when you make financial decisions based on a whim you end up committing costly mistakes. It is always important to ask yourself questions like are my expectations realistic? Better still consult a professional in that market, say a stock market professional or a real estate broker who would give you an independent view on the subject. This would help you come to a proper decision.
The writer is director, My Financial Advisor.