What does “framing” do to our thinking?
Photo: Dag Carolus. Source: Wikipedia
Frames are important. The create the setting for a picture. They can protect it and highlight what the artist wants us to see, or make a small picture seem much bigger. Frames have been used for thousands of years.
In our thinking, people tend to react differently depending on the way information is presenting. If you hear that a new colleague is efficient, hard-working, insensitive, and cold, your impression will be different than if you hear they are insensitive, cold, hard working, and efficient. In both cases, the information is the same. It’s just been presented differently—in a different order.
A researcher asked a group of people a hypothetical question: suppose you knew that a population had been infected with a deadly disease, but there were two new treatments available. Statistically, the treatments were the same. But participants chose the more positively framed treatment over three quarters of the time.
Source: Kahneman & Tversky, “The Framing of Decisions and the Psychology of Choice.” Science (1981)
There are all kinds of examples of framing. In marketing, people tend to buy things early if a late purchase has a penalty attached, rather than if they get a discount for an early action. In our current political season, politicians will spin a news item to present it in their favor. They didn’t lose an election, they “suffered a setback.” When I was in high school, I had teachers who called their tests “learning experiences.”
Investors have to be sure that they don’t frame themselves out of making good decisions. Logically, the order we hear information or the context does not affect the truth-value of the information. Making a decision in a problem should not be affected by how the problem is described. But it is. Irrelevant information can have an impact on how we see things.
Suppose you hear that Company XYZ has struggled all year, but finally saw its price pop up. By contrast Company ABC has been steady for the past 12 months, and just recently had the market recognize its efforts. The information in both cases is materially the same, but ABC is presented in a more positive light. How can we be more objective?
One thing investors can do is invert the order of any proposition. If an investment is presented with a list of attributes, change the order of the list: put items in the middle at the front or back, or go in reverse order. It’s an old finance trick to present the most important items in a budget first, and the second most at the end—so everything in the budget looks critical to the enterprise. If we mix things up, and don’t just accept items as presented, we may gain some insights that aren’t initially apparent.
The other thing we should do is look at our investment choices a broader context—that of the entire portfolio, or even with our entire financial picture in mind. Studies show that investors who broadly frame their selections at the portfolio level make decisions that are clustered—simultaneous, portfolio-level trades that result in a less risky, more diversified portfolio. Stock-level traders, by contrast, demonstrate a disposition effect: selling winners and holding onto losers. Do this enough, and you end up with a portfolio of frogs and toads.
If we want to meet our financial goals, we need to be careful about how we look at our picture. Make sure you’re focusing on the information itself—by inverting, or by changing your focus—and not the gilding you see around the edges.
Douglas R. Tengdin, CFA
Chief Investment Officer