Don't Fall for Money Mind Tricks (Part 2)

By in Mind and Money, Personal Finance

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FRAMING

In Part one you learned about the perils of mental accounting and anchoring along with tips to combat these mental demons. Today, understand the impact of “LOSS AVOIDANCE” and “FRAMING.”

LOSS AVOIDANCE

This is one I dealt with in the sale of our home, just this month. Here’s how it works.

Eric Johnson, a professor at the Columbia business school, divides his students into two groups. He asks Group One how much they’d pay for a mug. The average response is about 4 bucks.

The second group is asked how much it would take for them to part with a mug they owned. Group Two needed eight dollars to give up their mug.

In essence, this is the same question, “What is the value of a mug?’ Why are the answers so disparate?

Owning something increases its value.

Why?

We don’t like to lose something once we have it. In short, we experience LOSS AVOIDANCE, which means, THE PAIN OF LOSING OUTWEIGHS THE JOY OF WINNING.

 How does this behavioral bias play out in real life.

In the stock market, we hold losers too long and sell winners too quickly.

We buy more than we need and then are hesitant to declutter because we don’t want to “lose our possessions” whether we need them or not.

Heck, I was hesitant to drop the sales price on our home because first off, it is a fantastic home, and secondly the price has fallen within the last 12 months and I’m upset about it. (We did drop the house anyhow, and saw lots more activity afterwards.)

Solution

Just becoming aware of the phenomenon of loss avoidance can help you recognize and combat it. Next time you lose a competition, or lose some money on an investment, evaluate the experience dispassionately and act accordingly. If the investments prospects have deteriorated, get rid of it. Train yourself to get rid of stuff you no longer need, and to shop mindfully so you don’t overconsume.

FRAMING

Decisions are affected by how they are “framed.”

Picture this scenario. You have a panel of children evaluating the taste of various cereal brands. The kids were served a variety of healthy and less healthy cereals. The cereals were randomly placed in boxes with colorful cartoon characters on them, or plain boxes.

The Result

The children preferred the “taste” of the cereal from the boxes containing the cartoon characters!

The sugar content or healthfulness of the cereal was irrelevant!

Of course we all know a “staged” home sells better than the same home filled with clutter.

Solution

This behavioral bias is tougher to combat than you might think. Everywhere you go, savvy marketers are creating a “buy” environment, with lovely merchandising and seemingly compelling offers. The best way to combat this one is to be extremely rational when making decisions. When you figure this one out, let me know :).

Stop by next time for the final installment of Don’t Fall for Money Mind Tricks (Part 3)

How do you combat your mental money tricks?

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IMAGE CREDIT; KIMHAS7CATS