❝It’s not your salary that makes you rich, it’s your spending habits.❞
-Charles A. JaffeI’m at my desk, feeling a bit bored, so I run downstairs to a Marshalls store. Marshalls is a discount store similar to TJ Maxx or Ross. I go there just to kill some time.After a few minutes, I head to the checkout line with an armful of clothes. I don’t need any clothes, but I can’t help it – everything is on sale!On my receipt, I notice the amount I saved is printed in very large numbers. I practically have to get a magnifying glass to see how much I actually spent.This focus on how much I saved versus how much I spent is the same reason I bought so many clothes, to begin with. I would pick up a shirt, look at the tag and find out I can get a $99 shirt for $33! What a deal!I never stop to think about whether this is the best use of my $33. Just because I save $66 doesn’t mean the shirt is worth $33.I ended up hyper-focused on how much I saved rather than how much I spent.HOW MUCH IS SOMETHING WORTH?It’s challenging to put a value on things. How much, for example, is your shirt worth? Economists would say that the shirt is worth more to someone who needs a shirt than it would be to someone already clothed with a closet full of shirts. And yet, that doesn’t seem to stop people with closets full of shirts from paying a dollar for more shirts.Since it’s difficult for us to figure out what things are worth, we tend to rely on shortcuts. One easy shortcut is to look at the price tag. When we see the price tag, we can see how the seller values the product, and it’s quite easy to decide whether or not we value the item above or below that. When they put it on sale, though, we keep the original price in mind when considering the item’s value.However, we shouldn’t care what the old price was. Let’s think about that for a moment. We spend so much time thinking about how much we are “saving,” but the base for that savings is a price at which nobody wants to buy it. It was a completely inflated price. The new price seems like a good idea ebcause we compare it to the original price. Is it as good a deal if we compare it to other things we could spend our money on? Is giving away $33 and getting a shirt in exchange the best use of that money, or could it be better used on something else…or saved?ANCHORING EFFECTBehavioral economists and psychologists call our tendency to latch onto the original price of an item anchoring.Since we tend to be better at valuing comparisons rather than absolute numbers, we try to find a number to “anchor” to. Most of the time, the anchor should have little or no impact on our decision, but we use it anyway.If you think about a physical anchor, it keeps a boat from drifting, effectively keeping it in the same general area. Once you throw the anchor, your boat can only drift within a certain range.It’s the same thing with the anchoring effect, except that it usually involves numbers or ideas.An anchor price is most often an arbitrary number that we latch onto and use when evaluating purchases. But we shouldn’t use arbitrary numbers to make good decisions.Money is the number one source of stress in people’s lives, above work, health, and kids. People with money disorders typically have faulty beliefs about money and cannot change their behavior even though they know they should.EFFECTS OF ANCHORINGThe price tag on merchandise is one kind of anchor, but there are others. Another one that we see a lot is a vehicle’s MSRP (Manufacturer Suggested Retail Price). They set the anchor and when you “talk them down” a few thousand dollars, you win because you got a deal. They win because it’s still a healthy profit margin. They were the ones who got to set the anchor, though, and we compare the final negotiated price to their anchor, instead of the absolute, intrinsic amount we would have used.Another form of an anchor price is the list price of a home. The list price shouldn’t make a difference when it comes time to value a house, but time and time again research shows that people fall victim to the anchoring effect.We can even anchor ourselves to our own behavior. Dan Ariely uses the example in Predictably Irrational that once we buy out first expensive coffee from a coffee shop instead of cheap coffee from a gas station, we have a new anchor set to what coffee “should” cost. Over time, paying more for coffee becomes easier and easier because we’ve anchored to the price of expensive coffee. In other words, we get used to paying the higher price.When it comes to repaying debt, another anchor that gets set for us is the minimum payment on credit card balances. On one hand, you might be tempted to think that the minimum is there to make sure people pay at least a certain amount; without the minimum, people might pay only a few bucks. The alternative viewpoint is that a credit card company wants to make interest and by anchoring your payment they can nudge you into taking longer to pay off your balance, lining their pockets in the process.First impressions are another example of anchoring. The old saying is that you never get a second chance to make a first impression. This is so powerful because of the power of anchoring. Suppose I was having a really bad day when we first met. I could have been short-tempered or otherwise seemed uninterested. How many times would you have to meet the “real me” to convince yourself that I’m not the jerk you met? How willing would you be to meet me that many times after that first impression?The anchors don’t even have to make sense. This is how powerful this bias is in our minds. If I asked you whether Mark Twain died before or after age 103 and then had you guess his actual age when he died, you would likely give a higher estimate than if I asked you if he died before or after age 31.MAKE ANCHORING WORK FOR YOUYou can try to use anchoring to your advantage, too! If you put together a spending plan, perhaps you have a policy on how you will spend money. For example, if a purchase is over a set dollar amount, you might check in with your partner. Or if there’s a particular kind of purchase, you have to check in with your values.By taking a step back and anchoring your spending to your vision for your life, your plan, and your values, you can use the anchoring effect to help you make sure you are aligning your spending with your values.FOCUS ON WHAT’S IN YOUR CONTROLYou get one life; live intentionally.If you know someone else who would benefit from reading this, please share it with them. Spread the word, if you think there’s a word to spread.To share via text, social media, or email, simply copy and paste the following link:Subscribe to Meaningful MoneyThanks for reading. If you found value in this article, consider subscribing. Each week I send out a new post with personal stories and simple drawings. It’s free, and there’s no spam.REFERENCES AND INFLUENCES