To what extent are decisions influenced by context?

I was lucky enough to be invited on a small tour of the Art Gallery of NSW operations area. It involved speaking to the experts and understanding how they rejuvenate and protect the works. There is so much to it – I had no idea.

In the framing department, we were introduced to a very wide variety of frames, and a lady who has been in this department for something like 30 years made a very interesting comment: “The frame is not supposed to disturb the viewer”, which I took to mean the frame shouldn’t distract the viewer from the real focus – the painting.

Difficult to avoid
The same can be said of financial decisions, and topics. The context in which a financial decision is made shouldn’t affect the decision itself, but in almost every case, it does.

Think, for example, about investors evaluating their returns. It makes a big difference if the frame is the past 10 years or the past year. Similarly, there is a big difference if the returns are critical to lifestyle or not. Making a loan to someone very important to you is different to making one to a stranger for purely commercial reasons.

Evidence confirms it
In the recent edition of the Journal of Behavioural Finance, two papers relate to this topic. In his paper Stock Returns and the Tone of Marketplace Information: Does context matter? Nicholas Mangee of Georgia Southern University explains how impossible it is for anyone to know in advance when and in what ways different variables will matter in predicting stock market prices. However, prices will be totally affected by how different market participants interpret the information they deem to be relevant. “Simply put, context is what gives information meaning for investors,” he says. In other words, stock prices will be affected by investors’ perception (framing) of the information.

He goes further to explain how the “textual tone” of market reports mimics the current feeling of the participants and therefore influence the way information is interpreted. The marketplace context and information-based sentiment are the key factors for explaining stock price returns.

In the past, researchers concluded that investor sentiment was not directly related to prices, but the present research shows that sentiment and tone have a direct impact on behaviour.

In another paper, Aggregate Investor Confidence in the Stock Market, Chris Meier concluded that overconfidence is directly associated with excessive trading and risk taking. He shows how various impulses affect investors’ beliefs about their ability to predict security prices and interestingly enough, also how this increased confidence results in higher trading for around two months. As this overconfidence subsides, trading reverses in the third month implying that rational traders correct the initial overreaction. The first frame is replaced by another.

Use framing to win debates
From a social perspective, it is easy to win debates with friends or family by simply changing the frame. When we hear somebody with a strong opinion who has based their view on their own anecdotal evidence, by quoting broad-based statistics or some alternative anecdotal evidence, the argument can be easily won. Millennials are regarded as being impatient, and have a ‘frame’ – “I need it now“ – that often results in overspending.

From a financial perspective, the topic of framing is so important because it has a massive influence on all short-term decisions, and this is where most cost is incurred. People often make decisions about money based on short-term information, and long-term implications are seldom effectively analysed.

Antidotes
Every day we encounter facts and then make up stories to get these facts into some order so they make sense. The problem with this natural behaviour is that it creates frames, and given our natural inclination to find the shortest way to an answer, we repeat the frames at potentially the wrong time.
A useful antidote is to change or remove the frame. Let’s say your portfolio produced a 20% return. Based on average returns, you conclude it’s good and you’re very happy. If you reframe it by looking at similar portfolios and find they averaged 25%, it now makes you unhappy. Alternatively, you can simply remove the frame and just accept the fact that the returns are 20%.
Removing the frame and accepting the facts as they are is possibly too difficult a step for most people. To some extent, it requires us to suspend thought and evaluation – and this is challenging. Context is always going to affect decisions whether we like it or not. It’s more about being aware of the context and how it’s influencing the decision, and being clear about the ultimate purpose, in order to make appropriate decisions.