I was recently shopping for note cards on a popular paper company’s website. I know that has the potential to win the ‘least interesting opening sentence in a blog post’ award this year, but do your best to hang with me here. This shopping experience started out in a very promising way. I basically knew what I wanted and the home page of the site had a prominently displayed tab for Note Cards. How much easier could it get? Unfortunately, when I clicked on the Note Cards tab my thoughts of quick and easy were quickly replaced with thoughts of painful and confusing. I had entered some alternate reality where the inhabitants spoke a language I did not understand.
Paper Industry Gibberish
The best I can describe it is that they spoke in some sort of paper industry gibberish. They wanted to know whether I wanted to buy A2, A6, A7 or A9 note cards. I thought to myself, “Oh man, I was really hoping to buy some A10 note cards.” Of course I didn’t think that. I thought, “I have no idea what they are talking about!”
It was then I realized that the paper industry speaks in a language I do not understand, but that I’m sure makes perfect sense to people who work in a paper supply store. To the average person on the street, this “paperese” makes about as much sense as the ancient hieroglyphics written on the walls of King Tut’s Tomb. For those of us not fluent in paperese, a Paper Industry Gibberish to English Dictionary would be very helpful.
Financial Gibberish to English Dictionary
This got me thinking about the financial industry and how we often speak a foreign language as well. We talk about asset allocation and standard deviation and investment policy statements. I’m guessing these terms make very little sense to people on the outside of the industry. So, as a public service here is my first entry in the Financial Gibberish to English dictionary:
Asset Allocation: The easiest way to understand asset allocation is to think of your investment portfolio like a pot pie. When making a pot pie you want to find the right mix of ingredients that balances taste and nutrition. If the pot pie you create is really nutritious, but tastes like decomposed grass, then it is not going to do you any good because you are going to spit it out. On the other hand, if it tastes great but is terribly unhealthy, then it is going to hurt you over time. You don’t want a pot pie that is filled with nothing but gravy, but you probably will not long enjoy a pot pie that only consists of mushed veggies.
If you think of your portfolio like a potpie, then the ingredients of this financial pot pie are simply the different things that you can invest your portfolio in (like stocks and bonds). Your asset allocation is like the recipe that tells you what amount of each ingredient should go into your portfolio. In the end, you are trying to create a recipe (an asset allocation) that balances risk and return. You can think of the risk as the “taste” and the return as the long-term nutritional value.
Filling a real pot pie with nothing but gravy may taste good, but will fail to give your body the nutrition it needs, and may actually harm you over the long run. In the same way, filling your financial pot pie with nothing but cash and bonds may taste good to you at first, but will probably fail to give you the return you need over the long run. On the other hand, if you fill your portfolio pot pie with nothing but a few stocks, you will probably spit it out of your mouth at some point. A lot of people’s portfolio pot pies suddenly tasted like decomposed grass during the 2008 market decline and they sold everything!
I have to go now, I’m really hungry for some reason.