Wise Bread Picks
The cognitive bias known as anchoring gets a bad rap. This universal mental accounting quirk causes us to rely on the first piece of information we hear to make decisions. For instance, let’s say you’re thinking about saving up for a down payment on a house when you learn that a coworker just bought a house for $375,000. Suddenly, that number becomes your anchor point, and you compare all other home prices to this number.
This becomes a serious problem if the average home price in your area is wildly different from what your coworker paid. If most first-time buyers spend something closer to $200,000, you’re likely to overspend because your view of normal is skewed too high. (See also: 5 Mental Biases That Are Keeping You Poor)
However, financial anchors can do more than just warp your sense of an appropriate amount to pay. Intentionally adopting anchors can also help you to make better money decisions. Here’s how.
Monthly payment decisions
There are basic rules of thumb for what percentage of your income you should spend on housing, car payments, and the like. For instance, you’ll often see the claim that you should not spend more than 30 percent of your monthly income on your rent or mortgage.
To make this an anchor point that can actually help you make better financial decisions, take the time to do the math and use your anchor point as a hard stop for what you are willing to spend. If you net $3,500 per month income, you could plan to spend no more than about $1,000 per month on rent. ($3,500 x 0.3 = $1,050).
If you decide ahead of time that your anchor point is the absolute maximum you are willing to spend, then it’s easier to say no to the options that may seem like they’re only a little bit outside of your price range. After all, an apartment that rents for $1,200 per month may not seem like a big stretch above your 30 percent rule, but it adds up to an additional $2,400 per year.
With an unyielding dollar amount already chosen before you begin looking at apartments, cars, or other big ticket items you plan to pay for monthly, you can help prevent temptation from encouraging you to outspend your budget.
Even if the 30-percent rule is unreasonable for the area where you live, you can still use the process of creating an anchor point to help you stay within the budget that makes sense for your area.
I’m an avid audiobook listener, and have been an Audible subscriber for several years. Despite being a financial expert, I regularly cannot figure out if it makes financial sense for me to purchase an audiobook outright or use one of my “credits” for the purchase. That’s because I pay nearly $16 per month to subscribe to this service. Each month, I receive a “free” credit, which means I’m paying $16 for each monthly credit.
So it feels like I’m wasting money if I use a credit on an audiobook that costs anything less than $16. But if I buy the inexpensive audiobook outright, then I’ve spent my monthly $16 fee plus the cost of the audiobook.
Anchoring could help me to make these decisions less onerous. If I set an anchor point of $10 as the maximum amount I am willing to spend (rather than credits) on an audiobook, it’ll give me a mental shortcut to help me make quicker and more economical decisions.
Any fun items you like to purchase can benefit from a similar hard anchor point. If you love buying notebooks, shoes, music downloads, or the like, setting a hard limit on the maximum amount of money you can spend on any one purchase will make it easier to leave the tempting but expensive items on the shelf.
Of course, even with such an anchor, you still need to make sure you know how much you’re spending overall. Each purchase below your anchor can still add up to quite a large amount if you’re not paying attention. (See also: How Keeping Up With the Joneses Can Actually Save You Money)
If you’re time-strapped, hiring someone to help you with necessary but unpleasant tasks can be a huge lifesaver. However, for a lot of people, the costs of a housecleaner, dog-walker, or personal assistant can feel far too high. Many will decide that they’ll just do the mopping or other tasks themselves. The problem with this plan is that it still keeps you time-strapped, and it’s likely the tasks will go undone or poorly done.
Anchoring can help you to make the decision about whether it’s worthwhile for you to hire help. Calculating how much your time is worth will give you a baseline that’ll help you determine what you can afford from service providers.
To figure out your hourly net worth, divide your annual income by 2,000. (The average American works about 2,000 hours per year.) That means if you earn $60,000 per year, your hourly income is $30.
If the housecleaner you’re interested in charges $115 per month for bi-weekly cleaning, you’d have to decide if their two visits to clean your home from top to bottom will save you more than 3.8 hours each month that you would otherwise spend cleaning (or annoyed at the messy state of your home). The anchor point of your hourly net worth can put the cost of a service in perspective since it gives you a concrete amount to compare.
Update your anchors regularly
Creating personal anchors to help you make better financial decisions can give you a great mental shortcut. But it’s important to update your anchors every so often — once a year — to make sure you’re not making important new decisions with outdated anchors.
Your money choice shortcuts are only as good as the anchors you’re using, and if you’re making decisions based on your income from a more lucrative job, the prices in a lower cost-of-living area, or old prices that have risen because of inflation, then you’re likely to overspend, frustrate yourself, or even get embarrassed when you use an outdated anchor. (Imagine my embarassment when I realized I’d been using the anchor of “tip delivery drivers $1” for many years after my parents taught it to me in the early ’90s.)
Use your anchors wisely
Knowing the maximum that you’re willing to spend on something gives you a great way to know when to say no. Having such a hard-and-fast rule allows you to make smarter decisions more quickly and with less temptation.