Framing Effect, Clinton’s Odds to Win, & Your Finances
In the aftermath of Donald Trump’s surprise presidential win a lot of people are shocked and upset. They are upset for a lot of reasons, mostly personal and political, but I would like to add one more.
The framing effect.
Heading into election day prediction sites and betting markets gave Clinton large odds to win. Five Thirty Eight gave Clinton a 72% chance of winning. Other places had her at 80% and a few went as high as 90%. An 80+% chance of winning is very reassuring and it made a Clinton victory seem all but certain.
But people are bad with probabilities. They were ignoring the 20% chance that Hillary could lose. Then when Hillary Clinton did lose the reality became more painful for those expecting her to win.
This is the framing effect.
The Framing Effect is how we respond to and draw different conclusions from data as it is presented to us.
For example. You’re ill and surgery is the only cure. The Doctor tells you 1 out of 10 people don’t survive 1 month after surgery.
Would you undergo the surgery?
What if instead the Doctor came in and said the surgery has a 90% 1 month survival rate?
Would you undergo the surgery?
Even though in both situations the exact same data is presented, studies have shown that people are more likely to say “No” in the first situation and “Yes” in the second.
The fist situation is presented as a potential loss, a big one, and not as a percentage.
The second situation is presented as a gain and a 90% chance feels like a certainty.
Re-Framing Hillary Clinton’s Odds of Winning
Instead of giving Hillary Clinton an 80% chance to win. What if it was presented like this?
“20 times out of 100 Clinton will lose this election.”
It is the same odds as before but it is now presented as a loss. People are more averse to losses and seek to avoid them. Also, it removes percentages. People respond better to whole numbers and 20 out of 100 seems like a large number.
Presented this way Hillary Clinton’s loss doesn’t feel so surprising.
If Clinton’s chances were presented as a loss would this have motivated more Democratic voters to get out and vote?
Framing and Finances
There is probably nothing more suitable to the framing effect than equity markets.
The following example comes from Charles Schwab. Which investment do you prefer A or B?
A. One of your investments, XYZ, increases in value by $50 over the course of the year, but loses $20 of that gain due to some year-end market volatility.
B. One of your investments, XYZ, increases in value by $50 over the course of the year. The markets hit a rough patch near the end of the year, but you’re able to hold on to $30 of your gain.
It doesn’t matter. Both scenarios are the same except for how they are presented. Scenario A is presented as a loss and Scenario B is presented as a gain. Again, when people have to chose between which investment they prefer they consistently choose B.
The next example comes from A Wealth of Common Sense. It highlights how we can come to different conclusions about the current investing environment depending on how the data is presented to us.
Here’s an example using different starting points for annual returns on the S&P 500 along with their ranks based on historical performance data:
Based on this data and how you want to interpret the numbers you could make the following arguments:
- The 10 and 15 year numbers are well below long-term averages so the market can’t be too extended from here.
- The 5 year numbers are well above average and are unsustainable so the market must either crash or see lower returns going forward.
The Framing Effect is another cognitive bias we suffer from when making decisions. We can’t stop ourselves from thinking this way. We have to be aware of it and know that it can harm us financially. We have to slow our decisions making down and employ techniques to engage our rational thinking systems. Our financial decisions should not be made quickly. They should be made only after deliberate consideration.
Thinking, Fast and Slow by Daniel Kahneman