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

By in Mind and Money, Personal Finance | 8 comments

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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

    8 Comments

  1. Loss avoidance is a biggie in the stock market. Everyone always wants to get to even and will hold on despite long odds of that happening. I still have to struggle myself with emotion from time to time when trading.

    optionsdude

    May 22, 2011

  2. Hi Options, I think this one may be one of the most widely held beliefs among investors. Intellectually, it seems so reasonable, even though its a “money mind trick.”

    Barb

    May 23, 2011

  3. When I was in the restaurant business, someone said people eat with their eyes! If it looks good, it will sell. Talk about framing! We are taught that presentation is everything. Should we be surprised with the results? Packaging, marketing, image, and advertising influence us way too much. I am as guilty as the rest because I bought into all status symbols when I achieved success.

    krantcents

    May 23, 2011

  4. @Krantcents-It is almost impossible to avoid being sucked in, even if you are aware of the tactics. In food and in life, appearances and presentation influence perception.

    Barb Friedberg

    May 23, 2011

  5. Barb, yet another example of how emotions can get in the way of intelligent financial decisions. Great example, by the way!!!

    Finanzas Personales

    May 23, 2011

  6. I can’t get enough about the psychology of money, and investor behavior.

    I heard of another academic experiment where a professor was teaching framing, while incorporating the concept of recency.

    Studente were asked to write down the last two digits of their social security numbers. They were then asked to bid on a number of random items. Students with higher SS numbersbid much higher for the items than students with lower SS numbers. Simply focusing on the two difit number influenced their immediate behavior.

    Hunter

    May 24, 2011

  7. I guess we develop attachment to things we own. It’s tough to get rid of things that we are familiar with. I’m terrible with holding losers too long and I think I probably should stick with index investing for that reason.

    retirebyforty

    May 24, 2011

  8. @Finanzas-Yes, and much of the time we don’t even realize our emotions are guiding us.
    @Hunter-That is so fascinating. I’ve seen that sort of “recency” time an again. I agree that the topic is a fascinating one.
    @Retire-You are certainly not alone wrt holding losers too long. It is probably the most common investing dilemna.

    Barb

    May 24, 2011

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  1. Don't Fall for Money Mind Tricks (Part 3) | Barbara Friedberg Personal Finance - […] Part two, the insidious LOSS AVOIDANCE and FRAMING were […]
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