A Healthy Diet and Portfolio

"So many people spend their health gaining wealth, and then have to spend their wealth to regain their health." —A.J. Materi

Harvard's School of Public Health once published their "Healthy Eating Plate", an evidence-based guide founded on the latest and best scientific evidence to act as a blueprint for a healthy meal. In essence, it suggests that better health begins with a properly balanced diet.

Proper investing is just like having a balanced meal at every sitting. Unfortunately, some of us find it as hard to give up the idea of fun, exciting investing as it would be to give up that tasty char kway teow. After all, there is no better feeling than picking an investment that turns out to be a big winner and then boasting about it to friends and family.

There are lots of articles espousing the wisdoms of asset allocation, diversification, trading costs and more, but many people still see investing as an end in itself – rather than a means to an end. But always gunning for the best and greatest in investing is just like eating a steak for breakfast, lunch and dinner. You may still get your nutrition, but there would be many detrimental side effects along the way.

So, why do so many investors still invest this way? A big part is the human tendency to be overconfident. The overconfidence effect and the concept of illusory superiority are well-known and researched upon behavioural biases. For example, most people believe themselves to be above-average drivers, even though that is mathematically not possible. In investment, many likewise believe that they have powers of prediction and knowledge that others don't.

Yet even having more knowledge than others doesn't always translate to success. This study by the National Bureau of Economic Research found that corporate managers and executives had a poor record of prediction on their own firm's stock market returns, despite seemingly having insider knowledge. In fact, their estimates and the actual outcomes were negatively correlated - meaning that the result was often the exact opposite of what they expected!

Interestingly, research also points that men have a greater tendency to trade a lot and make over-confident forecasts about the stock market. This gender bias could be a result of a testosterone-driven evolutionary instinct to be the "alpha". Studies also show that men find it harder to accept that they are unlikely to beat the market.

What then would the ideal "healthy and balanced investment diet" look like? Of course, it would include accepting that you need to work with the market and not trade against it, and that you need to diversify away the systematic risks, trade efficiently, exercise discipline and watch your costs. However, like a diet with the proper amount of vegetables, fruits, whole grains and healthy proteins, this probably sounds too boring and unexciting to many people.

So, what can you do if you really want that plate of char kway teow (aka exciting stock picking, or leveraged options and FX)? You must separate your investment nest eggs from your play money. If you really want to speculate on the market, you can do so - provided that your investments for your important goals like retirement or your children's education are invested in the healthy and boring way. This way, the bulk of your money will be left to focus on the long-term drivers of return which have been shown to be persistent and pervasive.

Fret not: investing can still be a fun hobby. When you manage your money in the way we suggested, you will still be able to have your entertainment and accumulate war stories to be shared with your friends the next time you meet them at the pub or golf course. In fact, you'd be more able to do so, since any mistakes won't risk destroying your financial security. You also won't end up compromising the asset allocation and portfolio that were so painstakingly designed for you and your family to meet your life goals.

This separation of proper investing and speculative trading is just like your diet. If you have a balanced nutritional programme, you can still have your cheat days to indulge in that bowl of laksa or ice cream, and you won't feel the consequences as badly.