Imagine that you’re playing Let's Make a Deal, the long-running TV game show. There are three doors in front of you. Behind one there is a million dollars, but behind the other two are goats. If you pick the door with the money, it’s yours. I’ll give you the option of being able to pick any one door or any two. Which option do you prefer?
It’s a no-brainer, right? Without even doing the math you’d know that your chances are much better with two doors than one (a 66.7% probability of winning versus a 33.3% probability, if you’re into statistics).
What if I told you that, by asking this same question in a different way, most people would pick the one-door option? It sounds unbelievable, doesn’t it? Well, this is the way our mind works: we make systematic thinking errors called cognitive biases, and they cause us to make bad decisions.
We all make bad decisions like this in real life too. Have you known anyone who put money into fixing an old car, only to realize that the car has many other problems that will cost even more to repair? Even if they realize the car is a “lemon” they may keep sinking more money into it. Why? Because giving up on the car would make that previous spending feel like a loss, even though that money has already been spent. This is an example of the sunk cost fallacy, and is a result of a framing effect.
I’ll reframe the Let’s Make a Deal question and explain it later. First, let’s explore what I mean by framing and how you can use framing to make better decisions.
In this article I described how you are just about guaranteed to lose money by keeping it in a bank account that pays a very low interest rate, and how you are just about guaranteed to make money by keeping it in a low-cost, diversified stock market index fund over a long period of time. Viewing your money in these accounts over such a time period is an example of framing.
Framing can take the form of viewing things over different time periods, as in this case, or viewing things relative to some past event, or in many other ways. Even if you are not aware of the concept of framing, you do it all the time. Unconsciously adopting a frame can limit your ability to make a good decision. However, choosing to frame a question in different ways can dramatically increase it.
The frame can be thought of as all of the things you see, know, are told about, imagine, or otherwise sense around a specific object, belief, or idea. Take a look at the figure below. Of the two tables, which one is longer? I’ll give you a hint - just ignore all of the parts of the drawing except for the lines forming the sides of the table tops. If I told you that the two tables are the same size, would you believe me? Try measuring them on your screen and you’ll find that they are. This is an example of a visual framing effect. Even though I asked you to ignore all of the other lines, they still probably influenced your perception of the length of each side of the table.
Now let’s consider a real life example of framing a financial gain (or maybe it’s a loss). In 2009 I had a friend who, after working for about 35 years and steadily investing a little each month, built up about one million dollars in his retirement account. I estimate that over those 35 years he invested about $50,000 into the account. That’s a gain of $950,000 - close to one million dollars! With that account, I’m sure you’ll agree that my friend was in the process of setting himself up well for retirement.
Now, would you believe that some people saw this gain of nearly a million dollars as a loss, and used it as an example of why you shouldn’t be invested in the stock market? Here’s how those people framed my friend’s good fortune. The year 2008 was very bad for most stock markets around the world. As a matter of fact, my friend’s account dropped from about $2,000,000 at the beginning of 2008 to about $1,000,00 in early 2009. Friends and family members asked him “how can you stand to have lost that much money”?
So, which is true, did he lose a million dollars or gain a million? Both are true, actually. If my friend had known for certain that his account would drop that much in 2008, he surely would have moved his two million dollars out of the stock market and into cash, and be one million dollars wealthier in 2009. It is also true, however, that if he would have put his original savings in a piggy bank he would only have $50,000 instead of $1,000,000 in 2009.
The difference in whether it is viewed as a gain or a loss lies in what information we use to frame the events. As for my friend… he left most of that one million in the stock market funds for a few more years, and the market more than doubled over that time. So he’s doing fine.
Houses vs. Headphones
Before I get back to Let’s Make a Deal, here’s one last real life example of framing. Have you ever purchased a small electronic device, like headphones, and been asked if you would like to pay for an extended coverage warranty? You may frame this by comparing it to buying homeowner’s insurance, and think, “I like the peace of mind I get from paying for insurance, so I should pay for more coverage in case my headphones go haywire”. Buying homeowner’s insurance generally makes good sense, because most people have a large part of their wealth in their home. Even though a fire, tornado, or other event which can destroy a house is an unlikely event, the result would be devastating. You probably don’t own any spare houses, and you probably don’t plan on purchasing many of them.
How many electronic devices do you own? What are they worth? What are the chances they would fail? How much do you pay for additional warranties for them? If you frame your headphone purchase in the same way as your house, you might think spending money for an additional warranty is a good idea. But what’s so special about headphones?
Surely if it makes sense to get a warranty for your headphones, it makes sense to get warranties for any and all of your devices. Let’s frame the decision as part of all your other device purchases, including your televisions, smartphones, tablets, refrigerator, etcetera. Since most people purchase a lot of these devices over their lifetime, it costs a lot of money to buy additional coverage for them, much more than you would suffer in losses when a few of them fail prematurely.
Here is a detailed account of how you are probably wasting money if you keep buying these additional warranties. Yet even without going into details, you can see how framing all of these purchases together can change your decision. So stop wasting your money!
Getting The Right Door
And now, back to Let’s Make a Deal. This time I’ll just give you one guess at a door. After you make your choice, I’ll open one of the doors you did not choose. Since I know where the money is, the door I open has the goat. Then I ask “do you want to stay with your original choice, or do you want to switch doors?”
Most people, by intuition, think that switching doors will not help their chances of winning the money. They frame the question as “there are two doors remaining; which one has the money? My chances of winning are 50%”. If you framed the question in this way, I have good news for you, and bad. The good news is that your math is perfectly correct (1 divided by 2 = 0.5, or 50%), but the bad news is…YOU ARE INCORRECT!
Don’t worry, though, most people make this mistake, as did I when I first saw the question. Let me help by framing the question yet another way.
In my original proposal, your choice was between picking any one door or, alternatively, picking any two doors, knowing that at least one of them would definitely contain a goat. In the second case, since one door has now been opened and you know which one definitely has a goat, your choice is between staying with the one door, or effectively choosing the other two, with the specific knowledge of which one has the goat (assuming that you really don’t want the goat). Your probability of winning the million dollars by switching away from the first door is 66.7%, the same as choosing any two doors.
This is a case where more information can be confusing. If you’re still confused, here is a link going into more detail on what is referred to as the Monty Hall Problem, which contains a mathematical proof of why switching will give a 66.7% chance of winning. Wouldn’t it feel good knowing that you can increase your chances of winning for all decisions in your life?
Even a single reframing can be very helpful. Here are a few tips:
I hope that, by looking at these questions framed in different ways, you understand how important framing is. As you’ve seen, it can be even more important than getting the math correct. So the next time you are playing a game of probability, contemplating buying the additional warranty on headphones, or deciding whether to contribute to a retirement account, try framing your question in at least one different way to help you make the right decision and achieve your goals!
Questions to Ask Yourself
P.S. This tip sheet prepared by the author can help you make smarter financial decisions and consider signing up to the Intentional Insights newsletter.