Using Financial Anchors for Better Money Decisions

The cognitive bias known as anchoring often receives criticism. This widespread mental tendency makes us overly dependent on the initial piece of information we encounter when making decisions. For example, imagine you are contemplating saving for a house down payment and learn that a colleague recently purchased a property for $375,000. This figure then becomes your reference point, and you find yourself measuring all other home prices against this amount.

This can lead to significant issues if the typical home prices in your area vastly differ from your colleague’s purchase. If the average first-time buyers are spending around $200,000, you may end up overspending because your benchmark is set unnecessarily high. (Related: 5 Mental Biases That Are Costing You Money)

Nevertheless, financial anchors can affect more than just your perception of a reasonable price. By consciously establishing anchors, you can also make improved financial choices. Here’s how to do it.

Making Monthly Payment Choices

There are widely accepted guidelines regarding the percentage of your income you should allocate for housing, car payments, and similar expenses. For instance, it’s commonly suggested that you should not exceed 30 percent of your monthly income on your rent or mortgage.

To transform this into a useful anchor that assists you in making sound financial decisions, calculate your own limits and use this anchor as a maximum spending guideline. If your monthly net income is $3,500, aim to keep your rent to a maximum of about $1,000 per month. (Calculation: $3,500 x 0.3 = $1,050).

By establishing this anchor point as your ultimate spending limit in advance, it becomes easier to decline options that may seem only slightly beyond your budget. For instance, an apartment priced at $1,200 monthly might not appear overly excessive compared to your 30 percent rule; however, it results in an extra $2,400 each year.

Having a firm dollar amount determined before you begin searching for apartments, vehicles, or other significant monthly expenses helps mitigate the temptation to exceed your budget.

Even if the 30-percent guideline is unsuitable based on your locality, you can still create a personal anchor point that will help you remain within a budget that fits your circumstances.

Making Fun Purchases

As a passionate audiobook listener and long-time Audible subscriber, I often grapple with whether to buy an audiobook outright or redeem one of my monthly “credits.” Despite my background in finance, I find it challenging to assess which option is more economical. I pay around $16 each month for this service, receiving one “free” credit monthly, which means my cost per credit is effectively $16.

This leads to a feeling of wastefulness when using a credit for an audiobook priced lower than $16. Conversely, buying the cheaper audiobook outright results in spending my $16 subscription fee in addition to the audiobook’s purchase price.

To alleviate some of the decision-making burden, I can establish an anchor point of $10 as my maximum willingness to spend (without credits) on an audiobook. This mental guideline would facilitate quicker and more financially sound purchasing choices.

Setting strict limits on spending can enhance any enjoyable purchases you often make, be it notebooks, shoes, or music downloads. By having a predefined maximum expenditure, you’re less likely to succumb to the allure of pricey items.

However, maintaining awareness of your overall spending is essential, as accumulating lower-priced purchases can still lead to sizeable totals if not monitored. (Related: How Keeping Up With the Joneses Can Actually Be Beneficial for Your Finances)

Your Time

When you’re pressed for time, employing someone to handle necessary but unpleasant chores can be a significant relief. Still, many view the expenses associated with hiring a cleaner, dog walker, or personal assistant as excessive, often opting to manage these tasks personally. Unfortunately, this choice can leave you feeling time-starved, with chores potentially being neglected or completed poorly.

Anchoring can assist in evaluating whether hiring help is a smart decision. By calculating your time’s worth, you can assess what services you can afford effectively.

To determine your hourly worth, divide your annual salary by 2,000 (the approximate number of hours most Americans work each year). For instance, if you earn $60,000 annually, your hourly income is $30.

If a cleaner costs $115 for bi-weekly visits, you need to evaluate whether those two cleanings save you more than 3.8 hours each month that you would otherwise spend cleaning yourself or stressing about your untidy home. Knowing your hourly worth provides a valuable context for pricing such services.

Update Your Anchors Regularly

Developing personal anchors aimed at enhanced financial decision-making can serve as effective mental shortcuts. However, it’s crucial to revisit and update these anchors periodically—ideally once a year—to ensure that you are not relying on outdated information when making significant decisions.

Your financial decision-making shortcuts are only as effective as the anchors you employ. If you base your choices on a past income from a more lucrative job, expenses from a low-cost area, or old prices that have since risen due to inflation, you’re likely to overspend or face frustration down the line. (I still remember feeling embarrassed when I realized I had been using the outdated tip guideline of “a dollar for delivery drivers” that I learned in my early childhood in the ’90s.)

Utilize Your Anchors Wisely

Understanding your spending limits allows you to confidently say no when necessary. Having a rigid rule in place enables you to make smarter choices quickly with reduced temptation.