What’s Food Got To Do With Investing?

Imagine you are enjoying a sumptuous four-course meal in a fabulous restaurant. The complete meal provides a wonderful adventure for the senses through a variety of enticing smells, flavors, textures and colors. The progression of dishes is carefully orchestrated, from the light appetite-stimulating first course, to a savory entrée, finishing with something sweet and satisfying. Many of the same concepts used to create such a meal also apply to investing for the future. What you already know about food can help with investment planning.

Consider all of the ways in which an extraordinary meal is similar to investing. If I hand you a menu, you know what to do. You make choices based on what you like, what your body needs and what you might really crave at the moment. Your choices are based on your particular needs and preferences. This is also true of your investment choices.  An “investment menu” should consist of four courses: cash, fixed income, stocks for the main course and real estate/other for dessert. The concept of the investment menu, and its correlation with meal planning, is a way of describing asset allocation.

The Investment Menu

When preparing a special meal for guests, you intuitively include a good variety of ingredients, i.e., diversify. The menu itself is a brief description, summarizing a complex entity. The investment menu likewise provides a description of your investment strategy. For example, an investment menu might consist of 5 percent cash, 40 percent bonds, 40 percent stocks and 15 percent real estate and other. In a multi-course meal, each course serves a unique purpose. It is the same with the major classes of investments.

The cash course, which includes savings accounts, money market funds and CDs, provides liquidity. You can access funds easily and the investments do not fluctuate in value. These investments are extremely safe, but do have risk. They do not generate much return, and therefore do not keep pace with inflation over time.

I like to equate the fixed income or second course with a hot soup on a cold winter day. Bonds provide a steady income stream with relative price stability. A bond is like a loan you make to a company. It pays a regular interest payment twice a year. You get your principal back at the end of the loan term. The returns are generally higher than those from the cash course, with a bit more risk.

Equities, or stocks, are the main course. If you need growth in the portfolio, as most of us do, this course will be the most substantial. It is also the most risky. You want to be well diversified within this category. That might include using stocks of US companies across the size spectrum from small to mid-sized and large. It would also include using stocks of international companies in both developed countries and emerging markets. Although the need for growth may be great, be careful not to overeat. Stock markets periodically remind us that the price of potential reward is risk. The composition of your main course will depend both on your personal needs and capacity to assume risk.

The dessert course, real estate/other, is a bit of a catchall, but real estate is a major category and should be included in most portfolios. Alternative investments have also become more important in the last decade or so. These might include gold, commodities (such as oil, gas, copper, other precious metals, etc.), venture capital and hedge funds. The dessert course allows for additional diversification beyond the traditional cash, bonds and stocks.

What Most People Don’t Know

Why should we care about the investment menu? It reflects the most important decisions an investor has to make, the percentage of assets that are invested in each “course” or category. These choices reflect how much risk you want to take as well as how much the investments may grow over time. What most people do not know is that 85-90 percent of the return from a portfolio derives from the nature of the investment menu, that is from asset allocation. In other words, the percentage of investment in each major category is more important for returns than the individual investments you select. Individual investments typically generate only 10-15 percent of the return. Finding the next Google is not the path to a brighter financial future (though it couldn’t hurt!) It pays to focus on the bigger picture.

We know that in a meal diverse flavors are desirable. The same is true with investments. You should have investments in each of the four categories to be reasonably diversified. In addition, you should be diversified within each course. If you simply had a piece of grilled fish on a plate, it wouldn’t necessarily be that satisfying. Adding a relish of diced cucumber, minced shallot, tarragon, a little lemon juice and extra virgin olive oil transforms the fish into something much more interesting and delicious. Diversifying within each course on the investment menu is as important as combining multiple flavors on your plate.

In thinking about your investments, focus on what matters most – the investment menu. It offers the greatest opportunity to manage risk while contributing to potential returns. The investment menu is a picture, often represented as a pie chart (yet another food reference!) showing vital information about your investments. Just as with food, the choices comprising your investment menu reflect what is required for good (financial) health, as well as your personal preferences and goals. If you want to build your nest egg and can take the risk, your menu will have a greater amount invested in stocks. If you are retired, or are more risk-averse, bonds will make up a greater portion of your investment menu.

Think about your investments as a wonderful meal you are planning. Carefully select the finest ingredients as if your best friends were coming to dinner. Creating an investment menu may not be quite as stimulating as a stroll through the farmers’ market, but it can be every bit as nourishing and fruitful.

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