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I started playing competitive volleyball when I was about 16 years old. I had played a little bit in gym class but had never really taken it seriously before. As it turned out, I was pretty good at it right away. I wasn’t particularly tall or strong, but I had a couple of things going for me. The first attribute was that years of moving hay bales on the farm had left my forearms so calloused that there was a near-zero chance of me feeling any pain or discomfort from a hard impact. The second advantage I had was springy legs. I could jump high enough to compete with much taller players.
Fast forward 25 years. I had played volleyball on and off through my twenties and thirties, and after a 3-4 year break, was returning to the court again in a charity tournament. Thankfully, the only person in the gym who knew me was my wife…because it did not go well. After a full day of playing defense, my forearms started to sting. I was attacking balls straight into the net throughout the day. It seemed that nobody told my hitting arm that my legs could no longer boost me 36 inches in the air. After one defensive dive, I was a little slow to get up and I heard my only fan scream out, “You’re forty, you fool!” She was right.
The ball and the net didn’t care that I had bouncy legs, once upon a time. I should have known that I needed to adjust my game. My body had changed over the decades, and I was still trying to play it as if I was a teenager. Unfortunately, it took a pretty rough day and at least one injury for me to learn a valuable lesson about something called “Anchoring.”
Anchoring describes the subconscious use of irrelevant information as a fixed reference point for making subsequent decisions.
My past abilities were irrelevant to my situation on the court. My pain (both physical and psychic) was a result of my anchoring off of that irrelevant information.
I can hear you wondering, “Why are you writing about this here? Don’t you talk about finance?”
The simple answer is that anchoring bias is something that affects investors quite often, and it’s worth discussing. Sometimes, an investor will anchor off of the original purchase price of an investment (as in, “I’ll just get back to even.”). More recently, an investor may fall victim to the temptation to anchor off of a “high water mark.”
Let’s take a look at the extremely volatile Nasdaq Composite Index. At the time of writing this, its closing price was 11,524.05. If you bought the Nasdaq two years ago, you are showing a return of +4.69%. If you bought three years ago it’s +43.9%. If your purchase was made five years ago, you are showing a return of 77.77%
Here comes the bad news. As of today, the one-year return on the Nasdaq Composite index is -22.52%. The index is down almost 30% from the all-time high that it reached in late 2021.
Here is the important question. If you had invested $10,000 in the Nasdaq in September of 2017, would you look at your $17,777 balance today and say “I’ve made over 75%,” or “I’ve lost nearly 30%?”
Our logical mind recognizes the true unrealized gain in this investment. Our more primitive brain can fall victim to anchoring bias, and perhaps only see the comparison between today’s value and the all-time high of the index, when this data point is actually irrelevant. This perception of loss can lead to stress
Tomorrow I’m going to go play volleyball again. My wife is already reminding me that I’m no 16-year-old (now 45). Let’s hope I remember that truth once the game begins.
Related: Even the Rich are Broke!