Framing the Frame

Jim Murray took my original clanky post on Framing, and reworked it to his flowing and superb style of narrative. Thank you Jim. Here is the reworked version:

Behavioral economics is the study of decision making in an economic and financial context.

Daniel Kahneman is one of the leading thinkers in the field. He is the only psychologist to have won the Nobel Prize for Economics. In his study of the process of decision making, he identified various ‘decision biases’ we are prone too.

Key among them is the propensity to be influenced by something called The Framing Effect.

Framing effects can occur where a decision is based on one set of facts which can be stated in different, but logically similar ways.

A simple example is that of the ‘glass half full’ versus the ‘glass half empty’. Both of these constructs say the same thing, but in different ways.

Another example would be the contrast between some event having a 10% chance of failure versus that same event having a 90% chance of success. Same event. Two different ways of looking at it or framing it.

The Framing Effect In Financial, Economic & Domestic Decision Making

We make financial and economic decisions within a certain context or frame, and if the frame should be different, our choices may be different as well.

Here are some of the findings behavioral researchers have discovered about The Framing Effect:

• In the Retail World: Many consumers would rather buy a product that is advertised as ‘Buy One, Get One Free’ as opposed to purchasing the same two items at a 50% discount.

• In the Stock Market: In the most common form of a share split, a share of $80 would split into two shares of $40 each. Researchers found that often there is a perception of increased value created when companies split their shares. For example, when Yahoo announced their share split, the share price surged by16% the next day.

• In The Investment World: If you risk 1% of your investment portfolio in a single share that goes to zero, you will probably be more upset than if your investment portfolio were to lose 1% of its total value.

• In Business In General: You might be far more inclined to take a risk if you were told you have a ‘one in six’ chance of succeeding, as opposed to being told that you had a 17% chance of success. If it was further stated that you have 83% chance of failing, you probably wouldn’t even think about it. All three state the same scenario. All that is different it how the statements are framed.

• In The Employment World: Many people would happier with a 10% salary raise when inflation is at 5%, than they would be with a 7% raise when inflation is at 0%. A 10% raise just feels and looks better, yet what really matters is the increase in actual spending power, which is much greater in the 7% to 0% case.

• In Everyday Life: One group of people are told that ground beef is ‘75% lean’ while another group are told that the same beef is ‘25% fat’. The ‘fat beef’ group percieved that their beef was much lower in quality and taste than the lean beef group.

Can We Avoid The Framing Effect When Making Decisions?

Charles Munger, the long-time business partner of Warren Buffett, had this to say:

“It is in the nature of things that many hard problems

are best solved only when they are addressed backward”.

In other words invert the frame.

If someone claims product has a 75% success rate, invert the claim by addressing it from the back-end. To wit: There is a 25% failure rate. Then ask yourself if you should purchase it.

Another way is to relate a percentage decision to absolute numbers. I have a 25% chance of succeeding which means that one time out of four I will succeed.

To make more balanced economic decisions; see the frame, invert the-frame, look at both and then decide.