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Monday, August 27, 2012

Don\'t Let the Original Price Haunt Your Decision to Sell


Carl Richards is a certified financial planner in Park City, Utah, and is the director of investor education at BAM Advisor Services. His book, “The Behavior Gap,” was published this year. His sketches are archived on the Bucks blog.

Over the last few weeks, there has been a lot of chatter about Facebook stock. The headlines all seem to echo each other by focusing on the opening price:

  • “Facebook gains after dropping under $19, half of initial public offering price” [Washington Post]
  • “Facebook hits record low for third straight session, falls to less than half of IPO price” [Mercury News]
  • “Facebook stock falls below half its IPO price” [Los Angeles Times]

These headlines are a prime example of our very human tendency to anchor to a number, and it's usually the first number we see. In this instance, they're referring to the number $38, Facebook's initial public offering p rice.

But here's the deal: the decision to buy, sell or skip Facebook stock shouldn't have much to do with its opening price of $38.

Because we're human and we like anchors, that $38 price is hard to ignore. Anchoring can lead us to make mistakes with other money decisions, too. For instance, Derek Thompson, writing for The Atlantic, highlighted how that first number can impact your buying decisions:

You walk into a high-end store, let's say it's Hermès, and you see a $7,000 bag. “Haha, that's so stupid!” you tell your friend. “Seven grand for a bag!” Then you spot an awesome watch for $367. Compared to a Timex, that's wildly overexpensive. But compared to the $7,000 price tag you just put to memory, it's a steal. In this way, stores can massage or “anchor” your expectations for spending.

It's common to see a version of anchoring when people are selling their homes. Not surprisingly, most sellers mentally start with the price they paid. Depending on the market and other factors, they may play around with that number a bit, but it's hard not to anchor to that original price.

Let's say a family bought a home for $300,000 back before the housing market crashed. Over time, the house climbed in value, but then the market came to a screeching halt, and the home's value dropped. Then the homeowners got a job offer in another city, so it's time to sell. Even though they know the market has gone down, it's hard to forget that they originally paid $300,000.

So they list the house for $300,000. A few weeks and then months go by, and finally there's an offer for $275,000. Because of anchoring, it can be incredibly hard for the homeowners to weigh the offer on its merits. After all, they already had a number in their heads.

We carry sets of numbers in our heads in so many ways, and without realizing it, those numbers can weigh down our decisions. In stead of acting in a way that best suits our needs, we get stuck because the numbers don't match. Maybe we bought a stock for $100, determined after a time that it didn't fit our goals anymore and decided to sell it. But the stock now sits at $75. Do you still sell or do you wait? You'll find it's incredibly tempting to wait in the hope the stock will get back to $100.

Numbers matter, but you need to avoid the trap of anchoring to a single number and making it the primary guidepost for your decision. The first number will rarely be the number that should matter the most to you. As I've discussed before, the only number that matters when you need to sell is the price today.