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Tuesday, August 28, 2012

Dangers of Framing

We discussed the flaws in mental accounting and how it negatively impacts our financial decision-making process. A key fundamental flaw in mental accounting is the effect of framing.
Framing is how we tend to view our mental accounting decisions. For example say you go to the big box store and look at the newest in computer tablets and you find a tablet you like for $500 but remember that the discount store around the corner is selling the same tablet for $400. It is an easy decision to buy at the discount store and save $100. The next day you go shopping for a new bed, and you find the one you want for $3000, but the store around the corner is selling the same bedding for $2900 saving you $100. Yet this time you purchase the $3000 bedding. Why did you make this decision? It is due to framing, in each case you saved the same $100, yet your framing of the matter was based upon the rate of discount. The 20% discount was far greater in your mind then the approx. 3.0%discount for the bedding. The reality is in both cases you would have saved the same amount of money $100 but chose to ignore the $100 savings in the second circumstance.
The danger of framing is what your benchmarks are and if these reference points are consistently meaningful. If the reference point becomes tied to a discount you will consistently make poor decisions about money.
Investment psychology becomes even more important as these investment decisions have numerous variables that can be mismanaged through poor mental accounting. These mistakes with money are constantly made by the majority of investors.
Your financial decision-making process is the foundation to any investment success. In my private practice I had used an Insurance company who created a marketing campaign in which they would provide Susan B Anthony Silver Dollars for us to hand out on initial prospect interviews. The slogan was “Even the US Government makes mistakes with money.” (the Susan B Anthony was minted the same size as the quarter, and many people purchased $3 Cokes at the soda machines) Most prospects found this humorous until they were exposed to the reality of how their financial decision-making process was consistently causing them painful mistakes with money.
Your focus point is once again in your money journal. Reflect back on what your focus has been with regards to sales. What is the last item you bought on sale and what was the deciding factor. Identity these for small and large ticket items and see if the mental accounting bias of your framing has caused you a loss of money. Once you identify what are important reference points for you, an understanding of the framing process will be easy to identify.  This self-understanding of your specific financial decision-making process will be the first building block that needs to be in place before you can successfully insulate and inoculate you from scams, fraud and predatory sales tactics.