Some time ago I was helping my wife make cookies. Everything was going well until she began looking for the salt. I had to question this. “Why are you putting salt in cookie dough? There is nothing salty about cookies.” She explained that almost every cookie recipe calls for a little bit of salt. It has something to do with bringing out the other flavors. I really can’t recall the full explanation because the world, as I knew it, had just been changed forever.
As it turns out, behavioral economists refer to my bias against salt in cookies as “narrow framing.” Rather than looking at all of the ingredients and how they work together to create a finished product, I was evaluating each ingredient independently.
Just like baking, there is a science to investing. One of the most well-regarded investment theories used by professional investors is called Modern Portfolio Theory. The basic idea of this theory is that by combining investment assets that behave differently from one another, the overall risk of the portfolio is reduced. Investors who follow this theory design portfolios that are intended to have pieces that will not perform as well as others at certain times. This is all based on the idea that no one knows when certain investments will perform better than others.