Second Theme – Frame Dependence

Frame dependence reference to the phenomenon of information not being analysed objectively but through the frame it is received. Some major issues in this regard affecting the investment decision-making are as below:

a) Loss  Aversion:

This is the reluctance to accept a loss, since a loss can lead to the feelings of regret (will be dwelled on more in point c).

Instead of cutting the losses, investors tend to hold on to the losers for too long and/or don’t sell the winners fearing they may lose further “gains”. This can lead to risk-seeking behaviour.

b) Self-Control:

Instead of viewing the whole portfolio as one investors tend to psychologically divide the portfolio into sub-portfolios in line with different goals.

This gives them a sense of control and is more to do with emotions. For example a young affluent investor may want to avoid the dividends for tax purposes while an elderly may want high dividend paying investments so they can use the cash flows to meet their needs and do not have to sell any investments.

c) Regret Minimization:

Regret is the feeling associated with making a bad decision in hindsight. In order to avoid and/or minimize regret investors may stay in comfortable “safe” investments (e.g. stocks and bonds) which can lead to a lack of variety.

Another issue can be that they may not sell profitable investments but rather use their cash flows for expenses.

d) Money Illusion:

This ties in with the concept of “Real Money”. When considering performance the real return (which takes into account the inflation) should be considered and not the nominal return.

As people normally think in terms of nominal, in high inflation environments they may think they are getting a higher return when actually they may not be due to the inflation effect.

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