This bias can be defined as one that encompasses making decisions about part of an investment portfolio, without considering the effects they will have on the portfolio in its totality. For years, we have used the analogy of an automobile when addressing the effects of this bias, as it helps one to see the interconnectivity of the many parts that need to work in harmony for the constructed item to achieve its purpose.
For example, your car or truck contains many diverse parts that are equally important in the functioning of the vehicle, such as the tires, steering wheel, battery, gas pedal, brakes, and numerous engine components. All of these are needed to safely transport you from Point A to Point B. Think about it for a second, if the vehicle contains no brakes how would you stop? If the vehicle contains no battery how would you start it? In either case, your vehicle simply would not function as you expect it to. The same holds true for properly constructed investment portfolios and why Narrow Framing Bias can be so destructive.
You might be thinking, of course that’s the case with vehicles, but what does it have to do with prudent investing? Great question and one that requires a deep and profound answer. At Nepsis®, we consistently remind investors that: “No one position should make or break the portfolio.” In other words, your stock portfolio should reflect a deep level of diversification on a position-by-position basis. Just as different components of a vehicle are used to facilitate various needs for the passenger, such as speed, safety, course control, etc., different positions in the portfolio are used for different purposes within the portfolio.
Typically, we have between 30-35 individual company stock positions in our portfolios. Each company is identified on a standalone basis and reviewed through our fundamental screening process to meet our stringent quality metrics. Our process then takes it one step further by ensuring that the addition of each new company stock position is viewed in light of how it interacts with the other positions that are already in the portfolio.
As with building a vehicle, each component is added to enhance the performance of the particular car or truck; so too should each company added to a portfolio enhance the overall “risk-adjusted” performance of the certain pool of investments. We highlight the word risk-adjusted because each position may not on its own provide the strongest case for gross return. However, because of its differing properties, each position, when added, reduces the overall risk of the portfolio. Just like enhancing the brakes of a sports car doesn’t make it faster but certainly allows for a safer and more effective car.
Remember, no one position should either make or break the portfolio. We believe Narrow Framing Bias pushes investors towards making emotional and myopic decisions on their portfolios. And when investors lose sight of the big picture, irrational choices often follow. If one views their portfolio as an entity in and of itself rather than focusing on a given part or looking at it as a bunch of unrelated parts, it helps break the grip that Narrow Framing Bias can hold on investors.
Advisory Services offered through Nepsis, Inc.; An SEC Registered Investment Advisor.