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Investor Psychology

Break Out of the Mold

A psychological quirk called framing can cause us to make poor decisions -- but you can break the mold.

One of the most insidious -- and effective -- tactics of penny-stock peddlers is the follow-up pitch. Maybe while hyping a stock they sense that you're not buying their inflated claims that it's a "surefire quadruple in just two months." So they pitch another stock that they say is less risky -- one that will only double your money in a few months. Both stocks are trash. But former penny-stock brokers have told me that simply by offering a less aggressive alternative, they could often close a sale to a more reluctant investor.

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What the brokers were instinctively taking advantage of is a psychological quirk called framing. Framing holds that how you present a proposition dramatically affects how people respond to it.

The classic framing experiment is based on an epidemic scenario. Here's the simple version: Subjects are split into two groups and asked to imagine that the U.S. is preparing for the outbreak of a rare disease, which is expected to kill 600 people. One group is given two treatment options and told that one, Program A, will save 200 people. The other group is also given two options for treatment but is told that with Program B, 400 people will die. The outcomes, of course, are identical. But by a 77% to 22% margin, the test subjects preferred Program A to Program B.

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Framing is effective in influencing our decisions because we tend to take mental shortcuts -- in other words, we tend to do as little thinking as possible. With the rare-disease scenario, we follow our simple human tendency to feel regret and avoid loss. In the case of penny stocks, the quick way of evaluating the second stock is by comparing it with the first.

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A matter of time. Framing is also associated with short-term thinking. "We are continually being drawn into a short-term time frame, in which our emotions play a bigger role in our decisions," says Frank Murtha, a behavioral-finance consultant with MarketPsych, which offers psychological-training services to traders and money managers.

Even though we should be thinking of our investments as long-term propositions, we may frame their performance using results and information posted in the past month, week or even hour. That can cause us to make rash decisions to buy or sell.

At the root of framing, as with so many psychological quirks, is how our brain operates. Researchers think that framing may be more of a right-brain phenomenon. That is, we use our brain's right hemisphere to put things in context, so we use it to quickly search for a frame. By contrast, the brain's left hemisphere is better at breaking down information into parts that can be analyzed.

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This is more than just neurological trivia. Psychology professors Todd McElroy, of Appalachian State University, and John Seta, of the University of North Carolina at Greensboro, figured out a simple way to have the left hemisphere kick in when making decisions: They had subjects either tap their right fingers or listen to the rare-disease scenario with their right ear. (Remember, the brain's hemispheres control opposite sides of the body, and they are apparently activated by stimulation on the side they control.) Subjects whose left hemispheres were stimulated in this way didn't show the framing bias. McElroy says that putting your computer monitor and keyboard on the right side of your desk, and looking and typing in that direction, will help your left brain make decisions.

In Murtha's view, framing is like a steadily hardening mold that we have to keep cracking to maintain a healthy perspective. His best advice on how to break out of the mold: Have a professional adviser or a trusted friend play devil's advocate to help you see the big picture.

Kiplinger's is partnering with Nightly Business Report on the "Your Mind & Your Money" series, funding for which is provided by the FINRA Investor Education Foundation. For companion video reports, tune in to NBR on your local PBS channel May 10 and 24.

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