Behavioral Finance

How Big is Big?

By, 02/05/2007

Is this a big number?

$87,000,000,000

What about this one?

$2,900,000,000,000

Are they both big? Is one big and the other bigger? Surely they couldn't be small! Ponder that for a moment…we'll get back to it.

Mr. Bush sent his 2008 budget proposal to Congress today. He's looking to spend about $2.9 trillion. Read the details here:

1. Bush's $2.9 Trillion Request is 'Sticker Shock'
By Editorial Staff, CNN Money
http://www.cnn.com/2007/POLITICS/02/04/bush.budget.ap/index.html

2. Bush Sends Congress $2.90T Spending Plan
By Martin Crutsinger, Associated Press via The Washington Post
http://www.washingtonpost.com/wp-dyn/content/article/2007/02/05/AR2007020500208.html

Framing is a psychological phenomenon where the context of presented data shapes, or "frames," our thoughts about it. Everyone does it—in fact many experts believe framing is natural to the human mind—a mechanism for context and understanding. Our Stone Age ancestors used framing to see that catching a bunny rabbit for dinner is a good appetizer, but snaring a Woolly Mammoth is the all you can eat buffet! Based on our hunger and needs, one is small and the other is big.

So, while framing may be innate, it can be used against us as investors. The mechanism in our brains built for framing isn't made to compute numbers and understand capital markets. Today's numbers all seem big and getting bigger. Most politicians and much of the media know this—and they use framing to make things sensational and scary.

As it turns out, both the numbers above, $87 billion and $2.9 trillion, are small put into the proper context.

$87 billion is the cost in 2006 of the Iraq war. Sounds like a lot, but if we frame it properly, that is, in the context of the size of the US economy, it's tiny.

$87,000,000,000 (Cost in 2006 of the Iraq war)
÷
$13,322,600,000,000 (2006 GDP for the US)

= 0.7% of US GDP

In sum, the war costs less than a percent of US economic output. We're not here to argue about the validity of the Iraq war. That's up to you and your ideology. We're simply stating that whether you like the Iraq war or not, it's not an economic issue. And if you believe it's an economic issue, then it's a tiny economic issue. The Iraq war won't sink stocks or the economy.

Guns and Butter: How War's Expense Didn't Strain Economy
By Deborah Solomon, The Wall Street Journal (*Site requires registration)
http://online.wsj.com/article/SB117064184821097897.html?mod=hpp_us_pageone

(Just for fun, try to see how many times framing occurs in this article. We only had time to get through the first five paragraphs or so, and found at least a dozen. Our favorite is "No one knows when this bonanza [economic prosperity and high tax revenues] might end, although end it must.")

Let's look at a different example.

Bush's proposed budget for 2008 is $2.9 trillion. Jeepers! That could buy a lot of cattle on his Texan ranch!

Actually, the proposed budget represents about a 3.5% gain from the year before—just a little above the pace of economic growth for the US. So in relationship to GDP, budget growth is virtually flat. That's not big…that's pretty small.

Big, by definition, is a relative concept. Nothing can be big or small unless it's in relationship to something else, unless there's context. A good investor won't be fooled by bad framing—the good investor finds the right frames to see how big big really is.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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