In her eponymous book “Salt, Fat, Acid, Heat, Samin Nusrat lays down the 4 basic principles of good cooking.
She says and I quote “there are only four basic factors that determine how good your food will taste: salt, which enhances flavor; fat, which amplifies flavor and makes appealing textures possible; acid, which brightens and balances; and heat, which ultimately determines the texture of food.”
Looking at these elements the thought that will strike anyone who is passionate about cooking is how simple it seems, however most amateur cooks or equivalent of “bathroom singers” don’t appreciate enough how following principles makes a difference to how a dish will taste and how the recipe becomes irrelevant when the basics are done right.
I couldn’t help but draw a parallel to how investors need to think about investing principles that can make the recipe irrelevant.
Most advisors will state “behaviour management” to be their number 1 challenge when dealing with investors.
Often enough financial and behavioural theorist have put up mechanisms or principles to manage behaviours
Risk is often not appreciated by investors till they face it. For different investors it has different meaning and that’s why I feel “Risk” is to investing as “Salt” is to cooking;
Right from loss of capital to mark to market losses to loss of opportunities. Any of these or all of these could be equivalent of Risk to an investor.
Most experts would however put “permanent loss of Capital” as the only real risk. However for investors it is important to understand what risks means to them and not what some expert states risk is.
Perception of risk is more important for investors psyche than its textbook definition and so while some people prefer low salt content other prefer their food to be fully flavoured and just as food taste is individual so is risk.
Just the way salt defines flavour, understanding of risk defines how an investor will compound.
From retirements, education, house, car, marriage, lifestyle maintenance to just the kick that investing gives, varied investors have varied objectives.
Professional chefs are not just particular about the flavour but even the texture of the food as it’s the texture that makes the food presentable. The texture of the food comes from its fat content.
When the buffet of an investor is laid out, the objectives and how well they are defined not just increases the probability of its achievements but also makes it attractive to embrace.
Advisors need to ensure that right amount of “FAT” ( read “objective”) is added to the recommendation to make the meal attractive to the investors.
Knowing their objective can potentially make an investor accept their risk profile and make it more palatable than the lack of it
Acid adds balance to a dish just like asset allocation does it to investing.
Maintaining asset allocation in good times as in bad helps manage behaviour and makes sure compounding happens.
Investors losing hope when markets crash or becoming exuberant when markets in upswing get the temptation to give up the asset allocation discipline that can completely ruin the discipline of investing.
Advisors recommending investors to change asset allocation basis short-term momentum do long term injustice to investor portfolios. Yes the investor will feel good in the short run to seem some profits in the bank instead of on paper, however the compromise on long term compounding that this imbalance will cause is like adding either too much or too less acid to that food that will imbalance the taste and ruin the dish.
Some people like their food crispy while others like it flaky and some want softness. Different people different expectations.
Just as Heat creates the magic that can determine the final outcome of the food as per individual expectations, similarly “ return expectations” determine the final contour of how the investment strategy will be designed and played out.
High return Expectations while being a conservative risk profile can cause serious distress and damage to the investor portfolio and psyche.
Managing these expectations and understanding the risk at every level that such expectation create can ultimately shape what the final dish will look like.
Investing is challenging not because of lack of intelligence but because of how individuals react to their own objectives, risk profiles, asset allocations and expectations.
Understanding them and reflecting on the same regularly, just the way one will do when one is cooking or giving instructions to someone on how they prefer their food, and can help the investor manage their investing life cycle better.
And finally as the introduction of “Salt, Fat, Acid, Heat“ explains Receipe becomes irrelevant when principles are understood.
Similarly products, timing, volatility becomes irrelevant to an investors when the principle are followed.