Your Money Or Your Life?
How the "framing effect" impacts our financial decisions
You walk into Walmart, and you see two cans of bug spray.
The first can says, “kills 99% of bugs.”
The second says, “leaves 1% of bugs alive.”
Odds are you will buy the first bottle because it emphasizes killing the bugs (the result you want), and the second emphasizes that a few bugs will survive.
That is the framing effect inaction, which describes how information is presented and has more impact on the decision-making process than the content.
Continue reading to learn:
How the framing effect causes us to take unnecessary risks
Why financial advisors don’t follow their own advice
How the insurance industry uses the framing effect against you
How you can use the framing effect to your advantage
Your money or your life
Past research has shown that due to the framing effect, people prefer a small but sure win to a probable—but not guaranteed—big win when it comes to gains, but the opposite is true when it comes to losses.
Most people would rather take a guaranteed $100 prize to an 80% chance of winning $200 and a 20% chance of winning nothing. But they would prefer an 80% chance of losing $200 with a 20% chance of losing nothing than a 100% chance of losing $100.
It’s irrational, but humans also suffer from loss aversion, so they will make irrational choices when a situation is framed in such a way that emphasizes the possibility of loss.
In a 1996 paper, researchers asked 320 University students about hypothetical situations where they would have to make decisions about saving lives and saving property.1
For example, they were told 600 people had contracted a fatal disease and that they were given enough medicine to save 200 lives. Alternatively, they could give a reduced amount of medicine to all 600 patients, and there would be a 1/3 chance they all lived and a 2/3 chance they all died.
They were given a similar situation about saving 600 properties from a hurricane; guarantee 200 properties are undamaged and 400 are destroyed or opt for a 1/3 chance all 600 properties make it with a 2/3 chance they are all destroyed.
In both scenarios, the safe choice is to save the 200 people/properties, and the risky choice is to roll the dice in an attempt to save everyone/every property but risk losing everything.
When it came to saving human lives, most people chose the risky option. They would rather have a 1/3 chance to save everyone (and a 2/3 chance of saving no one) than a guaranteed chance of saving 200 people.
When it came to saving property, most people took the safe choice and opted to save 200 properties and let 400 properties be destroyed.
Does making the risky choice with human life mean people don’t care about saving lives?
No.
It’s the opposite. Most people agreed that saving people was much more important than saving property, and they would rather take a risk in an attempt to save everyone than choose to let anyone die—even if it means a 66% chance all 600 patients died.
An important note is that in this experiment, people were making hypothetical decisions about other people’s lives and property. What happens if they make similar decisions about their own lives or investments?
A 1997 paper appropriately titled “Framing Effects and Arenas of Choice: Your Money or Your Life?” asked research participants about similar situations with a safe and risky option around their own lives and money.2 The results were the same—the majority of people made riskier choices with their lives than they did with their money.
If someone knows what you value most, it’s not hard for someone to frame a situation that preys upon your fear of losing that thing to nudge you into making overly risky decisions. In real life, this is an even bigger problem because scammers and bullshitters will not only use negative framing to nudge you towards a risky decision, but they will straight up lie.
Consider the lies told by Anti-Vaxxers and financial bull$hitters running investing scams. They will twist the truth, and report lies as facts to push you into overly risky decisions that will be detrimental to your health (not getting vaccinated) or your wealth (putting your money in a crypto Ponzi scheme.)
We can’t follow our own financial advice
It’s not that people are incapable of making rational decisions about important issues like health and money; the problem is that when the consequences of a decision impact you personally, you become too emotionally involved to see things clearly.
A 2015 study found that people acted much more rationally when making decisions for other people than when they made financial decisions for themselves. When we take a step back and remove our fears and desires from the equation, we are more than capable of making rational financial decisions.
If I still worked as a financial advisor, I would make this the centerpiece of all my marketing material. The most valuable service a financial advisor can provide is acting as an unbiased 3rd party with no direct skin in the game.
This allows advisors to provide you with rational financial advice—even if they would not follow that advice when managing their own money.
Financial advisors are, in fact, better at managing their client's money than their own. They say doctors make the worst patients, and advisors make the worst clients—at least when they manage their own money.
A 1990 paper found that financial advisors were more likely to take unnecessary risks with their own money than their clients when a decision is framed in a way that emphasizes negative outcomes.
As the title of the paper suggests, financial advisors are not immune from irrational thinking but tend to make more rational decisions when managing your money.
People are better at giving great advice than following their own advice.
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Framing Effect and insurance decisions
So far, we have established that when a decision related to your health or your wealth is framed in a way that focuses on the possibility of loss, you are more likely to make a risky, irrational decision.
With that in mind, it should be no surprise that the framing effect can be used to get you to buy insurance coverage you don’t need and overpay for insurance you do need.
A 1993 paper examined how people understand the risk that is being insured, the premiums they pay, and the benefits they receive in exchange for those premiums.3
An important finding is that insurance can easily be framed to make you pay more for inferior coverage.
One study found that people were willing to pay more than twice the premium for travel insurance that paid out for travel disruption caused by either terrorism or mechanical failure than a policy that paid out for travel disruption caused for any reason.
Of course, terrorism and mechanical failure would be covered under “any reason,” but inserting the possibility of a plane being hijacked or the landing gear failing inspires fear and nudges us into overpaying.
The researchers also found that the news and what’s trending online can impact our willingness to pay for different types of insurance. If a major flood led the news for several days in a row, you can bet that there would be an uptick in demand for flood insurance policies.
The more vividly we imagine the negative outcome of a specific risk, the more we are willing to pay for peace of mind. A fact that insurance companies are keenly aware of.
Reframing the framing effect
Once you know how the framing effect works, you can think of ways to use it to your advantage by reframing a decision in your mind to nudge yourself toward a positive outcome.
In this post, I reviewed research that showed how people have been able to save more money by tieing their saving plan to a “fresh start date” associated with new beginnings like the first day of Spring or your birthday.
Like with all cognitive biases, two things are true about the framing effect:
You’ll never completely remove it from your decision making
Knowing about the framing effect is half the battle
The next time you are making any important financial decision, take a beat and consider if you are feeling any strong emotions—particularly fear— that might be influencing your decision.
If you are making a decision based on fear rather than facts, it’s likely that the situation has been framed that way to get you to spend your money. Take some time to let your emotions come back down and evaluate the decision based on the facts and not the way the information is presented.
Consider picking up a copy of either of my two books:
The Financial Freedom Equation is for anyone who wants to work on their money management skills and is available here.
The Rational Investor is for anyone who wants to learn a simple, evidence-based way to invest their money, and is available here.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
Jou, J., Shanteau, J., & Harris, R. J. (1996). An information processing view of framing effects: The role of causal schemas in decision making. Memory & Cognition, 24(1), 1–15. https://doi.org/10.3758/bf0319726
Fagley, N. S., & Miller, P. M. (1997). Framing Effects and Arenas of Choice: Your Money or Your Life? Organizational Behavior and Human Decision Processes, 71(3), 355–373. https://doi.org/10.1006/obhd.1997.272
Johnson, E. J., Hershey, J., Meszaros, J., & Kunreuther, H. (1993). Framing, probability distortions, and insurance decisions. Journal of Risk and Uncertainty, 7(1), 35–51. https://doi.org/10.1007/bf01065313
The boom with the same title actually encouraged me to rethink how I was spending my time and energy (and money)
Good write up , well done