Every day we are confronted with making decisions on various choices presented to us. We believe that the way we make these decisions is based on a logical process. However, most times, our decisions process is influenced by the way the information is presented to us.
It is possible that you have favored buying one service or product over another because of the way it was presented to you. Due to what is known as the framing bias, these sorts of judgments are made.
In this article, we look at what framing bias is, how it affects your financial decisions, and ways you should guard against it.
Framing bias occurs when people make a decision based on the way the information is presented, as opposed to just on the facts themselves.
As such, the individual’s choice from a set of options is influenced more by how the information is worded than by the information itself.
Origins of the framing effect can be traced to the pioneering research of Israeli psychologists, Daniel Kahneman and Amos Tversky, who studied how various means of phrasing the same information influenced the responses to a hypothetically life-and-death situation.
In their study, participants were invited to choose between two treatment choices for 600 persons with a terminal illness.
The first option was framed positively - 200 lives would be saved. In the second option, the question was framed negatively - 400 people would die.
Results showed that 72% of the participants chose the first option for treatment when it was framed positively, i.e., as saving 200 lives. However, only 22% chose the same option when it was framed negatively, i.e., resulting in the deaths of 400 people.
The same facts presented in two different ways led people to make different judgments or decisions.
Framing bias is also evident in how we make financial decisions.
How an investment opportunity is “framed”, can cause us to change our conclusions about whether the investment is good or bad.
While looking for an investment, you are more likely to choose an investment vehicle or asset that claims to increase your investment 95% of the time, over one which claims you may experience downturns 5% of the time.
Fascinatingly, there is a significant likelihood of reflexive decision-making when investors are uncertain of all the data or when there are several unknown variables. Financial markets don't always reflect financial realities.
Investors' beliefs, perceptions, and desires exert a tremendous influence on many instruments and indexes.
For example, you are far more likely to notice a market decline and take corrective action (selling your shares) than you are to enjoy a bull market. With increasing returns, you are far less inclined to sell these shares.
As a result, it is crucial that, as an investor, you precisely determine whether macro biases, such as framing, are present while making a decision.
How can you protect yourself against framing bias?
As an investor, one thing you can do is always question the framing. Consider rephrasing the information you're reading to determine whether doing so influences your conclusion. The idea is to adopt a rational, reflective approach to decision-making and avoid making rash, reactive choices.
For instance, an equity research report may contain substantial amounts of opinion and prejudice.
Try to exclude any editorial or evaluative remarks and focus solely on the valuation's primary statistics and underlying assumptions. Instead of being influenced by how the material is presented, you should reach your own judgments.
The first step to avoiding framing bias is to avoid being carried away with appearances or the way information is presented to you. Once you understand it and can identify it, then you can counter it.
Before making a financial decision, you must analyze the available options and the characteristics of each.
Consider the good facts offered, but also attempt to discover the negative parts. This way you may compare them and choose which carries more weight in your decision.
Framing bias is hinged on your emotions or perceptions to affect your purchasing decisions.
This is why you should seek out the most pertinent facts directly connected to the usage and usefulness of the product or service you want to acquire. It's all about being objective in your evaluations.
Many of your decisions are made subconsciously, depending on your beliefs, past experiences, and memories, among other things.
You must thus devote time to analyzing your various buying possibilities. Ask yourself questions, conduct research, examine the numbers, compare reviews, etc. Cognitive biases will influence you to make erroneous choices. The "bandwagon effect" is another example of this phenomenon.
When you recognize the framing effect and take the appropriate precautions to prevent it, you will be able to make more educated purchasing decisions.
Thus, you will optimize your resources, consume more rationally, and be protected from the prejudices that influence your purchasing decisions.
When provided with information, always consider both the positive and negative perspectives. If you are given a negative frame, try inverting it to see if this alters your perspective on the matter at hand. Even if the circumstance is the same. It is your responsibility to consider both perspectives.
