As consumers, we’re often unaware of how much our spending decisions are influenced by cognitive bias, according to personal finance author Emily Guy Birken.
“The first time we hear a price for something, that becomes our anchor point for what is an appropriate amount of money we spend on something,” Guy Birken tells NBC News BETTER.
Guy Birken, who has authored four personal finance books, including her most recent “End Financial Stress Now: Immediate Steps You Can Take to Improve Your Financial Outlook,” says we usually form anchors based on what we’ve seen or heard instead of doing our own research.
For example, let’s say you aren’t sure how much an average home costs in your city, and your coworker mentions he recently purchased a house for $450,000.
Without realizing it, this price becomes an anchor for how much you think an average house in your city costs, Guy Birken explains, but the actual price range could be lower.
She says this cognitive bias is commonly used by marketers to trick us into making irrational spending decisions.
For example: A restaurant advertises a bottle of wine for $90. Guy Birken says the restaurant is actually using that as an anchor to convince you to buy the $28 bottle.
“Comparatively, the $28 bottle of wine is a steal,” Guy Birken says, “but you might have actually been perfectly happy with the $15 bottle of wine.”
Fight back against anchors by creating your own
There’s a logical explanation why our brains cling to anchors, says Guy Birken: “It’s because otherwise we would be overwhelmed with any decision we needed to make.”
But she says you can fight back against anchors by creating your own.
Set a maximum price for what you are willing to spend on something, she says, and make that your anchor.
For example, Guy Birken — a ardent audiobook listener — says she created an anchor to determine how much she will spend on audiobooks.
She pays $16 a month for an audiobook subscription. Every month she receives a “free” credit. But the credit isn’t really free, she explains — it’s equivalent to what she pays for the subscription.
If she uses her credit on a book under $16, she’s wasting it. Likewise, if she spends money on a less expensive book, she’s paying the cost of the book plus $16.
“There is no winning this mathematical calculation,” she says.
To make her choices simpler, she only purchases books up to $10 (with her own money), and she only uses her free credit on books that cost more than $10.
How to determine your anchors
A big reason why it’s difficult for us to make rational spending decisions, says Guy Birken, is because money has no inherent value.
“It actually only has value because we have all decided that it has value,” she says, “and so the reason why we are subject to anchoring is because we are dealing with this kind of theoretical item that doesn’t really exist.”
But she says there are ways to determine how valuable an item or service truly is to you.
One way, she says, is to calculate the number of hours you will have to work to afford it.
Let’s say you make about $35 an hour.
You’ve decided you want to hire a personal trainer. One charges $70 an hour — the equivalent of about two hours of work. Another trainer charges $40 an hour — slightly more than one hour of work.
Based on your lifestyle and expenses, you may conclude that a session is only worth about an hour of work, so you set your anchor at $40 an hour.
Another way to determine the value of something, Guy Birken says, is to compare its cost to the cost of something you love.
Let’s say you love craft coffee, which costs $2.50 a cup at your local coffee shop. You are also trying to figure out whether you want to spend $50 on a dress. The dress will cost you the equivalent of 20 cups of coffee.
Using coffee as an anchor, you can easily determine how valuable the dress is to you.
“That’s where anchoring can help you,” Guy Birken says, “is if you create your own mental anchor that means more to you than what money might mean.”
Anchors work with major purchases, too
Guy Birken and her husband, who live in Milwaukee, Wisconsin, have purchased three homes over the course of their marriage. Each time, the realtor tried to get them to look at houses outside their price range, she says, but they refused.
She explains why: If a realtor is encouraging you to buy a house that is $30,000 outside your price range, he may easily convince you it’s not much more — after all, the price won’t add much to your monthly payment.
“But it is that much,” Guy Birken says.
“You need to decide for yourself what you can afford and not allow other people to pull your anchor north,” she says.
You are in control
Guy Birken says anchoring empowers her to quickly make the best financial decisions possible.
“It allows me to feel more in control of my choices,” she says, “and I have less financial regrets.”