YOU BOUGHT YOUR house 10 years ago for $250,000. Now you're thinking of downsizing, so you put your house on the market -- for $600,000. No takers. After a few weeks, you reduce the price to $575,000. Then $550,000. An offer comes in for $520,000. You reject it and pull your house off the market, waiting for better times.
Homeowners have been doing this throughout Southern California and in other areas of the country where the housing market had previously been red hot. Why? Does this behavior make sense? Is it rational? What's the "right" price for your house?
There are two ways to look at a selling price of $520,000 for a house you bought for $250,000. One way is to start with what you paid for the house. With that as your benchmark, or anchor, $520,000 is a windfall. You've doubled your money in a decade.
The other way is to use your original asking price as your anchor. If you do that, selling at $520,000 will feel like a sizable loss.
Decades of research in decision-making has taught us that people depend a great deal on such anchors, or frames of comparison, in assessing the value of any deal. Unlike expectations, which are consciously held attitudes, people are influenced by anchors without even realizing it. If you ask college students if the average price of a textbook is more or less that $7,000, they look at you like you're crazy and say "less, of course." If you ask other students if the average price of a textbook is more or less than $12, they wonder if you've been asleep for 30 years and say "more, of course." Then ask both groups of students what they think the average price of a textbook actually is, and the first group will give an estimate that is more than twice the second group's. Even though the starting point that you've imposed on each group ($7,000 or $12) is absurd, it nonetheless anchors their subsequent estimate, though they don't realize it.
Is $279 a lot of money to spend on an automatic bread maker? When Williams-Sonoma first marketed these then-novel gadgets more than 20 years ago, no shopper knew what a bread maker ought to cost, and Williams-Sonoma didn't sell a lot of them. Then it introduced a deluxe, $450 model. The company didn't sell many of these either, but sales of the $279 model went through the roof. The deluxe bread maker made the regular one seem like a bargain. Conclusion: We are affected by anchors whether it's rational or not, whether we want to be or not.
And so, when irrational exuberance induces people in hot housing markets to put very high asking prices on their houses, the asking price, and not their original purchase price, will be the anchor for some, and having to come down from that price will hurt. How can $520,000 sting so much when it's actually a huge capital gain? Because another thing we have learned from research on decision-making is that people hate to suffer losses -- and they feel far more pain from the loss of a sum of money than they experience pleasure from the gain of the same sum.
That is why when people need to sell stock to raise capital, they are more likely to sell stocks that have gone up than stocks that have gone down, which makes little sense. First, there is a chance that a stock that's going down is going down for a reason. The company may be in trouble. And second, there's a tax liability when you sell a winner and a tax deduction when you sell a loser.
So why do people behave this way? Because people hate to suffer losses, and as long as they still own the stock, they can pretend they haven't lost money, no matter how much its share price has plummeted.
Knowing these quirks in decision-making helps us understand why some people take their houses off the market even when they stand to make a very large profit by selling them. Having been seduced -- by real estate agents, by the media, by their neighbors -- to set a high anchor, they will feel like losers even when they double their money.
Anchoring effects are pervasive. We just can't seem to do without them when we're buying or selling anything. And that buying and selling includes politicians.
Is Jones a conservative? Is Smith a liberal? How we assess candidates depends largely on whom we compare them to. Extreme libertarians and fundamentalists make conservative Republicans look moderate. Socialists and "bleeding heart" liberals make Clintonite "new Democrats" look moderate. Who knows what "moderate" really is? It serves both political parties to have extreme wings that serve as anchors so that their "official" party positions seem reasonable -- just as it serves a seller's real estate agent to show you a pricey house to make the one she wants to sell you look like a bargain.
We all are vulnerable to being manipulated by sellers who will try to nudge us in the direction of comparisons that serve their interests. But we can also be ill-served by anchors of our own making.