Easy Come, Easy Go

In his book, Why Smart People Make Big Money Mistakes, Gary Belsky relates a fable that goes something like this:

By the third day of their honeymoon in Las Vegas, the newlyweds had lost their $1,000 gambling allowance.  That night in bed, the groom noticed a glowing object on the dresser.  Upon closer inspection, he realized it was a $5 chip they had saved as a souvenir.  Strangely, the number 17 was flashing on the chip’s face.  Taking this as an omen, he donned his green bathrobe and rushed down to the roulette tables, where he placed the $5 chip on the square marked 17.  Sure enough, the ball hit 17 and the 35-1 bet paid $175.  He let his winnings ride, and over and over the little ball landed on 17, until he had amassed more than $262 million.  Feeling invincible, he once again bet it all on 17.  As the wheel spun and came to a stop, he watched in shock as the ball fell on 18 and he lost everything.  Broke and dejected, the groom returned to his hotel room.  “Where were you?” asked his bride as he entered.  “Playing roulette,” he answered.  “How did you do?” she asked.  To which he replied, “Not bad.  I lost five dollars.”

How’s that for creative framing?  While you may never have to present or “frame” the loss of $262 million to your spouse, we all face important financial decisions that need to be framed properly.  In the most basic terms, framing can be thought of as the way something is presented to you.

Better Frames, Better Decisions
This is incredibly important because the way something is presented to you will change your view or perspective of that thing.   And when your view of that thing is changed, then what you believe about it can change and that belief leads to action — because we ultimately act on what we truly believe.

The progression is subconscious, but it normally goes something like this:  Framing changes your perspective, your perspective changes your belief and your belief changes your behavior.  Because of this, framing can encourage helpful behaviors or it can encourage harmful behaviors.

Knowing that good financial decisions begin with good framing and perspective, here is what I believe is one of the most important frames that will help you make better financial decisions.

Cycles Are Normal
▪ Properly framed, you should view market cycles as a healthy part of normal economic and market activity. Improperly framed, you may view economic and market cycles as something scary and unusual.  This belief (born out of improper framing) will generally lead you to fear market cycles and to try to avoid them. This behavior will almost certainly hurt your returns over the long term.

▪ Even though market cycles are normal, it is important not to confuse “normal and expected” with “predictable and the same.”  Because of this, it is certainly a fool’s errand to try to time a cycle’s next peak or valley.  As Peter Lynch famously said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

▪ However, you can systematically take advantage of market cycles, not by predicting them, but by rebalancing your portfolio when market swings have significantly altered the value of various assets in your portfolio.  In essence, rebalancing helps you “buy low” and “sell high” in a disciplined way.

Pizza Anyone?
Framing is so critical because it can change your perspective, and ultimately your behavior (for better or for worse), on your important financial decisions.  Because as I said earlier, framing changes your perspective, your perspective changes your belief and your belief changes your behavior.  For this reason, good decisions start with good framing.  So the next time you have a big decision to make, stop and ask yourself (and a few friends), “Do I have this decision framed properly?”

On a lighter note (and as further evidence that framing impacts our behavior), framing can even make you feel better about the not so helpful behavior of eating an entire pizza in one sitting.  It is rumored that Yogi Berra was once asked into how many slices he wanted his pizza cut.  To which he answered, “You better make it four, I’m not hungry enough to eat eight.”