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Monday, 23 November 2009

Investors, You’ve Been Framed

Lakoff's Political Frames

Suddenly politicians are all excited about a psychological trick that’s been known about for years. This is in no small part due to George Lakoff who’s popularised the idea of ‘framing’ in political circles. In the simple terms that politicians will understand, framing is about using the right loaded phrases and words to position yourself.

So, for instance, the American Army engaged in a ‘surge’ in Iraq: a short-term, rapid build up and assault is what comes to mind, rather than a long-term commitment. Or consider the renaming of the aggressive British Ministry of War to the protective Ministry of Defence. Or the various euphemisms for firing people: “sorry we have to let you go”. Such phrases create frames and these cause underlying behavioural biases to trigger in certain ways. As usual with psychological tricks the effect of this on individuals’ investing habits is largely bad.

Goffman’s Actors

The history of frames goes back to the gestalt psychologist Erving Goffman who developed the idea of acting on a stage as a metaphor for the human condition. Goffman saw people as adopting different personas depending on the particular role they were acting out: grumpy blogger, grumpy father, grumpy cook because the wife’s gone shopping again, etc. In this world the way we present ourselves depends upon the situation – or ‘frame’ – and we create these frames through our interactions with others.

The thing about framing is that it isn’t a psychological bias – it’s simply the way we all make sense of the world all the time. We have no choice but to frame situations because without doing so we have no context. The trouble is that the way we look at things colours our perception.

So an investor unconvinced of the inevitability of global warming isn’t going to be much interested in the views of environmentalists however useful they may be in offering another way of considering the problem. Similarly people whose belief systems are framed by a view that free market capitalism is the only way of solving problems don’t tend to be very amenable to reasoned arguments about the socialisation of health care. Or anything else, to be frank.

Manipulating Frames

However, the issue is that we can manipulated by people adjusting our frame of reference. Because various behavioural biases will trigger in different situations if those situations can be manipulated then the biases can be made to fire unconciously. So if you tell a nicotine fiend that if they smoke for the next forty years their chances of getting terminal lung cancer will increase from 1% to 1.3% they’re likely to carry on inhaling. If you frame the argument by telling them that they’ll increase their chances of dying by 30% they’re likely to choke on their next fix.

Same argument, same numbers, different frame.

This, incidentally, is how the press manages to manufacture scare stories when there are none. So we get stories about knife crime increasing by 200% when this means the number of crimes has increased from 3 to 9 and then probably only because of improved reporting. Without frame manipulation half the stories in the tabloid press would disappear (see the Media, Fear and Stockmarket Mania for a fuller exposé).

A frame biases our perception of what’s happening, our underlying behavioural biases do the rest. Hopefully it goes without saying why this is such a powerful technique. In effect, by carefully constructing situations in certain ways we can be made to obey the wishes of third-parties and are left believing we made the decision of our own free will. And, in a way we did. No wonder framing is at the centre of political debates at the moment.

Money Frames

Turning to finance, back in 1981 Tversky and Kahneman described how framing the same situation in terms of either a loss or a gain can change the results obtained. In their own words they showed that:
“We have obtained systematic reversals of preference by variations in the framing of acts, contingencies, or outcomes. These effects have been observed in a variety of problems and in the choices of different groups of respondents.”
By changing the frame they were able change the reference point from which people made decisions: and that changed everything. So, for instance, people will drive 20 minutes to save $5 on a $15 calculator but won’t drive the same distance to save $5 on a $125 calculator. Yet rationally it’s the same saving – $5 – for the same cost – a 20 minute drive. What’s different is the frame, which is the cost of the item.

Portfolios, Stocks and Frames

The psychology of choice is rich with such examples, but the problem for most people is that they don’t even know that this is happening. Although potentially we could think about things differently, by framing the problems differently, all too often we don’t because we don’t recognise how limited our decision frames are.

One example of this, as applied to stock investment, is the way that we do – or don’t – frame our investments in terms of total portfolio value or net worth. Generally it makes no sense to talk about stock portfolio values independently of all of our other assets and liabilities – we can have a giant stock portfolio value because we’ve borrowed an even more giant amount against our houses to play the markets. Financial bulletin boards are full of these contextless – and therefore meaningless – descriptions of net worth.

A Disposition to Tight Frames

Beyond this, though, there’s an even more problematic issue of framing in the way some investors treat individual stocks. Kumar and Lim, for instance, in the snappily named “How Do Decision Frames Influence The Stock Investment Choices Of Individual Investors” suggest that people who frame decisions more narrowly make worse investment choices overall.

OK, so what does that mean? Well ‘narrow framing’ means that each investment choice – so, for example, each individual stock purchase or sale – is viewed in terms of itself only. The frame of reference is purely the individual company. In this context a wider frame would be something like our overall stock portfolio or even overall wealth. Of course, you might reasonably ask, what difference does this make? That’s the thing about framing – it never looks like it ought to make a difference, but the results indicate differently.

Generally those investors who exhibit narrow framing have relatively poorly diversified portfolios compared to those with a wider frame of reference and, as you’d expect, suffer greater volatility – which doesn’t necessarily equate to lower returns in the long term, but certainly equates to higher risk in the short.

Linked to this and underlying it is our old friend the disposition effect – the tendency to sell shares that have increased in price and to keep those that have decreased, an nasty bias we've previously met in discussions of Regret. The narrower their frame, the more likely the investor is to exhibit these tendencies. Which is what you’d expect if the eagle eyed investor is closely following their individual investments rather than a wider frame of wealth.

The Principle of Charity

Philosophers have recognised this problem for years and have a technique that they’re supposed to use to deal with it. It’s called the Principle of Charity and it demands that if you’re attempting to destroy someone else’s argument that you do your very best to understand their perspective, to make the best possible interpretation of what’s being suggested. This is a pretty unnatural thing for most people to do, who generally view an argument as something to be won, not something to do your best to lose.

Of course, in truth, philosophers use the Principle of Charity as a cloak in which to wrap bricks before throwing them through their rivals’ arguments. Nonetheless, an investor with fixed and tight frames would do well to try and use it. The alternative is to make sure that they’re right, all the time. And, of course, framed from their perspective, they usually are.


Related Articles: It's OK To Lose Money, Moral Corporations: An Oxymoron?, Bulletin Boards Are Bad For Your Wealth

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