Anchor and Adjustment

I am slowly making my way through Jason Zweig’s book Your Money & Your Brain which is credited as being one of the books that brought the topic of neuroeconomics into the mainstream.  I have been fascinated with some of the concepts and experiments that Zweig outlines in this book.  One of these concepts he calls ‘anchor & adjustment’ and is used to describe the process by which our brains operate in terms of coming up with estimates for answers we may not be certain about.

He gives the example of asking how old John F. Kennedy would be today if he were alive.  Go ahead and ask yourself that question.

If you’re like most people you might think 75-80 at first and then after taking longer to ponder the question adjust your answer higher to 85-90.  The truth is that JFK was born 05/29/1917.

When our brains are posed with a question and we are not certain about then our intuition “anchors” our initial guess.  This emotional response will typically be influenced by our previous experiences and memories (think of JFK’s youthful face).  However, with time, the rational part of our brain enters the estimation process and begins to use reason in determining our final guess.  Zweig calls this process the “adjustment” phase.  This is when most people begin to increase their guess of JFK’s age today.  However, because our initial guess was “anchored” in our emotional response by the time our rational brain takes over it is difficult to “adjust” our answer high enough to compensate for the initial anchor.  As a result, our final estimate is somewhere between the correct answer and our “anchor”.

For trivial matters like the aforementioned JFK question it may not make much of a difference.  However, in the financial planning process this is important to understand.  For example, if a household is estimating the return on their investment savings/ inflation and their assumptions are influenced by this process then the initial estimates could be far from reality causing them to under-save or over-save during their lifetime.

This process is biological in nature and impossible to reverse (without millions of more years of evolution).  Having said that, if we are aware of this process we can consider the impact that our emotions have on our ability to estimate things in our lives (including financial figures).