Oh, how a picture (which is worth more than a thousand words) can change depending on the type of frame you put it in. The same applies to the decisions we make.
Framing is how we make sense of the world. By framing situations we are able to make sense of the world, without which, we would have no context. However, the danger with this is that the way we look at things influences our perceptions.
If you had to tell someone addicted to nicotine or any other cancer-causing substance that continuing their consumption of such substance will increase their chances of developing cancer from 1% to 1,4% (I’m making up these numbers), they’ll probably continue consuming. However, framed differently, if you told them that their chances of dying will increase by 40%, they’re likely to have a more cautious response.
Another well-known example from Tversky and Kahneman says that people will drive 20 minutes to save $5 on a $15 calculator, but they will not drive the same distance to save $5 on a $125 calculator. However, rationally it’s exactly the same saving – $5. The only difference is the frame of reference, in other words the cost of the item.
I had to have another chuckle at myself on a recent trip to Helsinki. I wanted to visit Tallinn, Estonia, for one day. When budgeting for this, I was under the impression that a return boat ticket would cost me €90. Booking my ticket, I discovered that the ticket was actually only €40 (for the larger boat which takes two hours) and €50 (for the smaller boat which takes 1,5 hours).
Almost immediately I was going to book the €50 ticket. With my frame of reference being €90, this was a bargain. This was the chuckling moment. I must not be influenced by frames!
Seeing that I had a gripping novel in my bag and sufficient time on my hands to afford taking 30 minutes longer to get there, it made more sense to book the €40 ticket and save more.
From the viewpoint of an investor, framing also affects our investing decisions. I’ll discuss these in next month’s article.
Author: Gizelle Willows CA(SA) MCom Finance is Senior Lecturer in Financial Reporting at the University of Cape Town