Evidence Based Investing – Helping you invest successfully
It is crucial for everyone to have a sound financial plan, especially when the markets are volatile.
Over the past decades, with the rapid development in technology and science, countless academic research and studies have been published by economists and fund managers, demonstrating which investment strategies are likely to be successful. Despite all this information, and contrary to what you may think, the way in which people make investment decisions remain largely unchanged. As a result not many have achieved their financial goals.
While no investor would consider using a twenty-year-old mobile phone, many investors are using twenty-year-old financial products and services and are missing the opportunity to benefit from decades of academic research.
Although historical performance data has shown that active management strategies are rarely reliable, many fund managers still claim they are able to beat the market by using active investment strategies such as stock selection and market timing. In fact, not only does this approach often fail to deliver a portfolio that outperforms the market, it also increases the risks and costs that are borne by the investors. Evidence has shown that this results in underperformance most of the time.
Research over the last decades strongly supports the hypothesis that markets are more-or-less efficient. This hypothesis, appropriately named the “Efficient Market Hypothesis”, states that at any given time, the market has already taken into account all available information as it sets security prices accurately.
The approach of active managers is more like speculation and it is generally impossible to benefit from speculation in an efficient market. This should be good news for investors who invest for the longer term. It means prices for securities are fair and that asset allocation, and not mispricing, explains the differences in average returns. It is certainly possible to outperform markets, but not without balancing risks and costs against expected returns. Instead of trying to beat the market you should let the markets work for you.
This is also one of the fundamentals within the Evidence Based Investing approach. Using decades of Nobel-Prize winning empirical research, financial market theory, and scientific evidence has gained an insight into the factors which contribute to a reliable and successful investment strategy. This approach has gained attention in recent years, particularly in Asian markets, however this has been popular in the US for many years.
Creating a personal financial plan
Each of the last two decades has brought at least one major market downturn that has wiped out wealth that was built up over prior years. These market corrections have left many investors unsure of their ability to reach their financial goals through stock market investments. A diversified portfolio using the right mix of assets and strategies can smooth out market movements and allow investors to reach their investment objectives over time.
No one can reliably forecast the market’s direction or predict which stock or investment manager will outperform. All investment decisions involve risks, even the decision to not invest. Creating a financial plan based on the science of investing frees you to focus on what matters. Let markets work for you by taking advantage of sensible, well-diversified, low-cost portfolios backed by decades of research and practical experience.
The key to a successful financial plan is to focus on the things you can control. The plan should be in line with your financial needs and risk tolerance. It is important to be well diversified to help mitigate risk. Furthermore, you should also structure the portfolio along the factors of which evidence shows that they provide a higher expected return. Lastly, it is important to reduce expenses, and taxes where possible.
Markets have rewarded discipline and a disciplined investor looks beyond the concerns of today.
At The Capital Company we help clients focus on the risks that matter most when determining their optimal asset allocation. We work closely with our clients to ensure that their investments are aligned with their personal goals and help them remain committed through periods of market volatility.
Lodewijk Lamaison van den Berg is a founder and partner of The Capital Company, providing independent asset management and family planning services. Lodewijk can be contacted at firstname.lastname@example.org for any questions or comments.