When I was shopping for an engagement ring that was my starting point. If I spent less, I would have felt I was cheating my future wife out of the ring she deserved.
I bought that ring three years ago. At the time, I was living with “roommates” (alright my parents) rent free. Thus, saving two months of salary was fairly easy.
It’s funny to think back about my thought process, or the lack there of, at the time I was making the biggest purchase of my life. I never contemplated looking at a ring that was under two months’ salary. I’m very happy with the ring I bought, but I laugh at how I was stuck on two months’ salary.
Logically, the two month benchmark is the worst answer to the question, “How much should I spend on an engagement ring.”(Side note: The worst person to ask that too is your future mother-in-law.) Not surprisingly, that benchmark was created by the diamond industry.
The two questions you should use to determine the price you pay is:
- What can I afford?
- What do I want to spend?
Why does nobody buy an engagement ring using logic? Because of the behavior trap known as anchoring. Anchoring occurs when you attach a price to a reference point that should have no bearing on how much you pay.
This is why most people buy an engagement ring they can’t afford. That two month figure has been crammed into your head over and over again. If you don’t spend at least two months’ salary, even if you have to go into debt to do so, you’re friends are going to think your cheap.
Other Examples of Anchoring
There are many other examples of price anchoring that cause us to make irrational financial decisions.
For example, when you go to purchase a car, negotiations usually start based on the sticker price. Knowing this, car dealers often jack up the sticker price to create the illusion that the car is more expensive than it is.
Another example is that if you were to go buy a house right now, your Realtor will tell you how much the house WAS going for. For example, your Realtor might say, “In 2008 this house was on the market for $500,000 and now it’s down to $300,000.” The Realtor does this so you think the house is undervalued. Logically, the house is worth what a willing buyer and willing seller agree to today, not what it used to be worth.
How to Avoid Price Anchoring
To prevent price anchoring, you must first look at why you use anchors in the first place. Price anchoring is like a shortcut for your brain. With little thought, your brain can attach, or anchor, itself to a past reference point. Therefore, the cure for price anchoring is actual critical thought.
Instead of using past reference points for financial decisions, ask yourself these questions:
- Can I afford this today?
- What do I really want to spend?
- What are some contrarian alternatives?
- Would a CERTIFIED FIANCIAL PLANNER® do what I’m about to do?
In the comments, list any financial mistakes you’ve made in the past due to anchoring.
Photo by: Some Random Nerd