This Psychological Barrier Could Cost Your Portfolio Big Time

Investors are always looking for an edge when buying stocks. In this segment of “The Morning Show” on Motley Fool Live, recorded on Feb. 14, Fool.com advisor Jim Mueller, and Director of Small Cap Research Bill Mann share a helpful tip to consider when pondering a purchase.

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Jim Mueller: It’s called anchoring, you’re anchored on that price. Your brain does it without even realizing it. Which journaling, writing down what you’re feeling, writing down what you’re thinking helps overcome that, helps at least makes you aware of it so you can fight against it. But one of the hardest things to do is, what David does so well is buy at higher prices. Because you see your basis, it’s $50 ago. You’re saying, why should I pay more because you feel regret because I should have paid or bought more back then. Adding to your winners is an easy saying, but it’s hard to do. Because of that anchoring.

There’s an experiment that’s been done over and over again. It’s with an audience that doesn’t really know the answer to the final question. The experiment, it goes like this. Take the last three digits of your telephone number, any telephone number associated with you, and add 400 to it. If your telephone number has the last three digits of 737, then you would make it 1137. Write that down. Once you’ve done that, in what year was Attila the Hun defeated during his invasion of Europe?

Bill Mann: 1984.

Mueller: Write that number down.

Mann: I’m sorry. [laughs]

Mueller: The responses. The average guess of the year, most people don’t know when Attila the Hun invaded Europe and was finally defeated but if you grouped those phone number groups by quintiles, by 200s or 400s, I guess, by 400s, 20% by 400s. Then you average all those people within each quintile, The guess of the year. That yearly guess marches upward as you get to larger and larger numbers on your phone number. 99% of the people are wrong because he was defeated in like 400 or 500 AD.

Mann: 451 at the Rhine River.

Mueller: Yeah but you’re anchored on your phone number and that influences what you think about that question.

Mann: Interesting.

Mueller: This is described in a really good book, Your Money and Your Brain by Jason Zweig.

Mann: Brilliant. Required reading.

Mueller: Required reading.

Mann: Yeah.

Mueller: He then goes on to write that this anchoring is why realtors show you the more expensive house first.

Mann: Yeah.

Mueller: Then show you will slightly cheaper house that’s not nearly as good but because it’s cheaper, you’re more likely to buy it, because you’re anchored on that higher price.

Mann: Yeah.

Mueller: Investing, we look at the recent price chart, of course, we do. If the trend is up you’re saying, I should have bought back there. I’m going to wait until it falls back down, or if it’s fallen, you’re OK. Now, it’s back down to where it was six months ago but you’re less likely to buy because you’re anchored on that high price, what’s wrong with the company? What happened? What’s wrong? You’re not willing to buy then either. It’s a wonder we buy shares at all.

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