Investing vs. Behavior

A Tale of Behavioral Instincts

As investors, we are consistently at odds with our pre-programmed human behavior. That is, our basic-survival instincts often play against otherwise well-reasoned financial decisions. As such, the market may favor those who are better at overcoming their impulsive, often damaging gut reactions to breaking news. Once we complete our exploration of market return factors, we’ll explore the fascinating field of behavioral finance in more detail, as this “human factor” contributes significantly to your ultimate success or failure as an evidence-based investor.


Carl Richards Behavior Gap

 

 

 

 

 

 

 

 

 

 

 

In our last piece, “Investing Seeking the Future” we wrapped up our conversation about ways to employ stock and bond markets within a disciplined investment strategy. We now turn to the final and arguably most significant factor in an evidence-based investment strategy: the human factor. In short, impulsive/ behavioral reactions to market events can easily outweigh any other market challenges you face.

 

Exploring the Human Factor 

Despite everything we know about efficient capital markets and all the solid evidence available to guide our rational decisions … we’re still human. We’ve got things going on in our heads that have nothing to do with solid evidence and rational decisions – a brew of chemically generated instincts and emotions that spur us to leap long before we have time to look.

 

Rapid reflexes often serve us well. Our prehistoric ancestors depended on snap decisions when responding to predator and prey. Today, our child’s cry still brings us running without pause to think; his or her laughter elicits an instant outpouring of love (and oxytocin).

 

But in finance, where the coolest heads prevail, many of our base instincts cause more harm than good. If you don’t know that they’re happening or don’t manage them when they do, your brain signals can trick you into believing you’re making entirely rational decisions when you are in fact being overpowered by ill-placed, “survival of the fittest” reactions.

 

Put another way by neurologist and financial theorist William J. Bernstein, MD, PhD, “Human nature turns out to be a virtual Petrie dish of financially pathologic behavior.”

 

 

Behavioral Finance, Human Finance

To study the relationships between our heads and our financial health, there is another field of evidence-based inquiry known as behavioral finance. What happens when we stir up that Petrie dish of financial pathogens?

 

Wall Street Journal columnist Jason Zweig’s “Your Money and Your Brain” provides a good guided tour of the findings, describing both the behaviors themselves as well as what is happening inside our heads to generate them. To name a couple of the most obvious examples:

 

  • When markets tumble – Your brain’s amygdala floods your bloodstream with corticosterone. Fear clutches at your stomach and every instinct points the needle to “Sell!”
  • When markets unexpectedly soar – Your brain’s reflexive nucleus accumbens fires up within the nether regions of your frontal lobe. Greed grabs you by the collar, convincing you that you had best act soon if you want to seize the day. “Buy!”

 

An Advisor’s Greatest Role: Managing the Human Factor

Beyond such market-timing instincts that lead you astray, your brain cooks up plenty of other insidious biases to overly influence your investment activities. To name a few, there’s confirmation bias, hindsight bias, recency, overconfidence, loss aversion, sunken costs and herd mentality.

 

 

Your Take-Home

Managing the human factor in investing is another way an evidence-based approach helps to guide us- using data driven methodology instead of emotion.  By spotting when we (as investors) are falling prey to a behavioral bias, it is possible to overcome emotional decision making and implement a strategy based on rational observations.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Image Attribution: Carl Richards (c) 2013 Behavior Gap

Diversifying for a Smoother Ride

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Observation #1: A smoother ride builds confidence.

Observation #2: Confidence is important for the long-term investor.

 

In our last piece, “Managing the Market’s Risky Business,” we described how diversification plays a key role in minimizing unnecessary risks and helping you better manage those that remain. Today, we’ll cover an additional benefit to be gained from a well-diversified stable of investments: creating a smoother ride toward your goals.

 

Diversifying for a Smoother Ride

Like a bucking bronco, near-term market returns are characterized more by periods of wild volatility than by a steady-as-she-goes trot. Diversification helps you tame the beast, because, as any rider knows, it doesn’t matter how high you can jump. If you fall out of the saddle, you’re going to get left in the dust.

 

When you crunch the numbers, diversification is shown to help minimize the leaps and dives you must endure along the way to your expected returns. Imagine several rough-and-tumble, upwardly mobile lines that represent several kinds of holdings. Individually, each represents a bumpy ride. Bundled together, the upward mobility by and large remains, but the jaggedness along the way can be dampened (albeit never completely eliminated).

 

15 DFA Guesswork Investing

 

If you’d like to see a data-driven illustration of how this works, check out this post by CBS MoneyWatch columnist Larry Swedroe  “How to diversify your investments.”

 

Covering the Market

A key reason diversification works is related to how different market components respond to price-changing events. When one type of investment may zig due to particular news, another may zag. Instead of trying to move in and out of favored components, the goal is to remain diversified across a wide variety of them. This increases the odds that, when some of your holdings are underperforming, others will outperform or at least hold their own.

 

The results of diversification aren’t perfectly predictable. But positioning yourself with a blanket of coverage for capturing market returns where and when they occur goes a long way toward replacing guesswork with a coherent, cost-effective strategy for managing desired outcomes.

 

The Crazy Quilt Chart is a classic illustration of this concept. After viewing a color-coded layout of which market factors have been the winners and losers in past years, it’s clear that the only discernible pattern is that there is none. If you can predict how each column of best and worst performers will stack up in years to come, your psychic powers are greater than ours.

 


16 DFA Randomness of Returns

 

Your Take-Home

Diversification offers you wide, more manageable exposure to the market’s long-term expected returns as well as a smoother expected ride along the way. Perhaps most important, it eliminates the need to try to forecast future market movements, which helps to reduce those nagging self-doubts that throw so many investors off-course.

 

So far in our series of Evidence-Based Investment Insights, we’ve introduced some of the challenges investors face in efficient markets and how to overcome many of them with a structured, well-diversified portfolio. Next up, we’ll pop open the hood and begin to take a closer look at some of the mechanics of solid portfolio construction.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Managing The Market’s Risky Business

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What is a simple, one word answer to the Question: How can we manage investment risks?

 

The Answer: Diversification

 

There’s Risk, and Then There’s Risk

Before we even have words to describe it, most of us learn about life’s general risks when we tumble into the coffee table or reach for that pretty cat’s tail. Investment risks aren’t as straightforward. Here, it’s important to know that there are two, broadly different kinds of risks: avoidable, concentrated risks and unavoidable market risks.

 

  • Avoidable Concentrated Risks

Concentrated risks are the ones that wreak targeted havoc on particular stocks, bonds or sectors. Even in a bull market, one company can experience an industrial accident, causing its stock to plummet. A municipality can default on a bond even when the wider economy is thriving. A natural disaster can strike an industry or region while the rest of the world thrives.

 

In the science of investing, concentrated risks are considered avoidable. Bad luck still happens, but you can dramatically minimize its impact on your investments by diversifying your holdings widely and globally, as we described in our last post. When you are well diversified, if some of your holdings are affected by a concentrated risk, you are much better positioned to offset the damage done with plenty of other, unaffected holdings.

 

 

 

 

 

 

 

 

 

 

 

  •  Unavoidable Market Risks

If concentrated risks are like bolts of lightning, market risks are encompassing downpours in which everyone gets wet. They are the persistent risks that apply to large swaths of the market. At their highest level, market risks are those you face by investing in capital markets in any way, shape or form. If you stuff your cash in a safety deposit box, it will still be there the next time you visit it. (It may be worth less due to inflation, but that’s a different risk, for discussion on a different day.) Invest in the market and, presto, you’re exposed to market risk.

 

Risks and Expected Rewards

Hearkening back to our past conversations on group intelligence, the market as a whole knows the differences between avoidable and unavoidable investment risks. Heeding this wisdom guides us in how to manage our own investing with a sensible, evidence-based approach.

 

Managing concentrated risks – If you try to beat the market by chasing particular stocks or sectors, you are exposing yourself to higher concentrated risks that could have been avoided with diversification. As such, you cannot expect to be consistently rewarded with premium returns for taking on concentrated risks.

 

Managing market risks – Every investor faces market risks that cannot be “diversified away.” Those who stay invested when market risks are on the rise can expect to eventually be compensated for their steely resolve with higher returns. But they also face higher odds that results may deviate from expectations, especially in the near-term. That’s why you want to take on as much, but no more market risk than is personally necessary. Diversification becomes a “dial” for reflecting the right volume of market-risk exposure for your individual goals.

 

Your Take-Home

Whether we’re talking about concentrated or market risks, diversification plays a key role. Diversification is vital for avoiding concentrated risks. In managing market risks, it helps you adjust your desired risk exposure to reflect your own purposes. It also helps minimize the total risk you must accept as you seek to maximize expected returns.

 

This sets us up well for our next piece, in which we address another powerful benefit of diversification: smoothing out the ride along the way.

 

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Diversification: A Complete Meal

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What single action can you take to simultaneously dampen your exposure to a number of investment risks while potentially improving your overall expected returns? Diversification.

While it may seem almost magical, the benefits of diversification have been well-documented and widely explained by some 60 years of academic inquiry. Its powers are both evidence-based and robust.

 

Global Diversification: Quantity AND Quality

What is diversification? In a general sense, it’s about spreading your risks around. In investing, that means that it’s more than just ensuring you have many holdings, it’s also about having many different kinds of holdings. If we compare this to the adage about not putting all your eggs in one basket, an apt comparison would be to ensure that you’re multiple baskets contain not only eggs but also a bounty of fruits, vegetables, grains, meats and cheese.

 

While this may make intuitive sense, many investors come to us believing they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts. But upon closer analysis, we find that the bulk of their holdings are concentrated in large-company U.S. stocks.

 

In future installments of our series, we’ll explore what we mean by different kinds of investments. But for now, think of a concentrated portfolio as the undiversified equivalent of baskets full of plain, white eggs. Over-exposure to what should be only one ingredient among many in your financial diet is not only unappetizing, it can be detrimental to your financial health. Lack of diversification can:

 

  1. Increase your vulnerability to specific, avoidable risks
  2. Create a bumpier, less reliable overall investment experience
  3. Make you more susceptible to second-guessing your investment decisions

 

Combined, these three strikes tend to generate unnecessary costs, lowered expected returns and, perhaps most important of all, increased anxiety. You’re back to trying to beat instead of play along with a powerful market.

 

A World of Opportunities

Instead, consider that there is a wide world of investment opportunities available these days from tightly managed mutual funds intentionally designed to facilitate meaningful diversification. They offer efficient, low-cost exposure to capital markets found all around the globe.

 

 

Your Take-Home

To best capture the full benefits that global diversification has to offer, we advise turning to the sorts of fund managers who focus their energies – and yours – on efficiently capturing diversified dimensions of global returns.

 

In our last piece, we described why brokers or fund managers who are instead fixated on trying to beat the market are likely wasting their time and your money on fruitless activities. You may still be able to achieve diversification, but your experience will be hampered by unnecessary efforts, extraneous costs and irritating distractions to your resolve as a long-term investor. Who needs that, when diversification alone can help you have your cake and eat it too?

 

In our next post, we’ll explore in more detail why diversification is sometimes referred to as one of the only “free lunches” in investing.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

 

Financial Gurus and Other Unicorns

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Do Financial Gurus exist? Yes.

Do Lottery Winners exist? Yes.

Do you want to invest your savings in lottery tickets? No.

 

While Financial Gurus (experts at identifying mispriced investments) do exist; the overwhelming evidence shows that these gurus are few and far between; or as Morningstar strategist Samuel Lee has described, managers who have persistently outperformed their benchmarks are “rarer than rare.”

As investors we are better served letting the market serve us, rather than attempting to outsmart the collective knowledge of all other investors.

 

Group Intelligence Wins Again

As we covered in “You, the Market and the Prices You Pay,” independently thinking groups (like capital markets) are better at arriving at accurate answers than even the smartest individuals in the group. That’s in part because their wisdom is already bundled into prices, which adjust with fierce speed and relative accuracy to any new, unanticipated news.

 

Thus, even experts who specialize in analyzing business, economic, geopolitical or any other market-related information face the same challenges you do if they try to beat the market by successfully predicting an uncertain reaction to unexpected news that is not yet known. For them too, particularly after costs, group intelligence remains a prohibitively tall hurdle to overcome.

 

The Proof Is in the Pudding

But maybe you know of an extraordinary stock broker or fund manager or TV personality who strikes you as being among the elite few who can make the leap. Maybe they have a stellar track record, impeccable credentials, a secret sauce or brand-name recognition. Should you turn to them for the latest market tips, instead of settling for “average” returns?

 

Let’s set aside market theory for a moment and consider what has actually been working. Bottom line, if investors who did their homework were able to depend on outperforming experts, we should expect to see credible evidence of it.

 

Not only is such data lacking, the body of evidence to the contrary is overwhelming. Star performers – “active managers” – often fail to survive, let alone persistently beat comparable market returns. A 2013 Vanguard Group analysis found that only about half of some 1,500 actively managed funds available in 1998 still existed by the end of 2012, and only 18% had outperformed their benchmarks.

 

Across the decades and around the world, a multitude of academic studies have scrutinized active manager performance and consistently found it lacking.

  • Among the earliest such studies is Michael Jensen’s 1967 paper, “The Performance of Mutual Funds in the Period 1945–1964.” He concluded, there was “very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance.”
  • A more recent landmark study is Eugene Fama’s and Kenneth French’s 2009, “Luck Versus Skill in the Cross Section of Mutual Fund Returns.” They demonstrated that “the high costs of active management show up intact as lower returns to investors.”
  • In the decades between, there have been as many as 100 similar studies published by a Who’s Who list of academic luminaries, echoing Jensen, Fama and French. In 2011, the Netherlands Authority for the Financial Markets (AFM) scrutinized this body of research and concluded: “Selecting active funds in advance that will achieve outperformance after deduction of costs is therefore exceptionally difficult.”

 

Lest you think hedge fund managers and similar experts can fare better in their more rarified environments, the evidence dispels that notion as well. For example, a March 2014 Barron’s column took a look at hedge fund survivorship. The author reported that nearly 10% of hedge funds existing at the beginning of 2013 had closed by year-end, and nearly half of the hedge funds available five years prior were no longer available (presumably due to poor performance).

 

Your Take-Home

So far, we’ve been assessing some of the investment foes you face. The good news is, there is a way to invest that enables you to nimbly sidestep rather than face such formidable foes, and simply let the market do what it does best on your behalf. In our next installment, we’ll begin to introduce you to the strategies involved, and your many financial friends. First up, an exploration of what some have called the closest you’ll find to an investment free lunch: Diversification.

 

Evidence-Based Investment Series #4: Diversification: A Complete Meal

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Ignoring the Siren Song of Daily Market Prices

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Do you try to go to the gas station as soon as the price of oil futures change?  Probably not.

(And if you did, the price will probably have already changed by the time you get there.)

 

News, Inglorious News

What causes market prices to change? It begins with the never-ending stream of news informing us of the good, bad and ugly events that are forever taking place. For example, when there are reports that a fungicide is attacking Florida trees, orange juice futures may soar, as the market predicts that there’s going to be less supply than demand.

 

But what does this mean to you and your investment portfolio? Should you buy, sell or hold tight? Before the news tempts you to jump into or flee from breaking trends, it’s critical to be aware of the evidence that tells us the most important thing of all: You cannot expect to consistently improve your outcomes by reacting to breaking news.

 

Great Expectations

How the market adjusts its pricing is why there’s not much you can do in reaction to breaking news. There are two principles to bear in mind here.

 

First, it’s not the news itself; it’s whether we saw it coming. When a security’s price changes, it’s not whether something good or bad has happened. It’s whether the next piece of good or bad news is better or worse than expected. If it’s reported that the aforementioned orange tree disease is continuing to spread, pricing changes may be minimal; everyone was already expecting doom and gloom. On the other hand, if an ingenious new fungicidal treatment is released, prices may change dramatically in reaction to the unexpected resolution.

 

Thus, it’s not just news, but unexpected news that alters future pricing. By definition, the unexpected is impossible to predict, as is how dramatically (or not) the market will respond to it. Once again, group intelligence gets in the way of those who might still believe that they can outwit others by consistently forecasting future prices.

 

The Barn Door Principle

The second reason to consider breaking news irrelevant to your investing is what we’ll call “The Barn Door Principle.” By the time you hear the news, the market already has incorporated it into existing prices, well ahead of your ability to do anything about it. The proverbial horses have already galloped past your open trading door.

 

This is especially so in today’s micro-second electronic trading world. In his article, “The impact of news events on market prices,” CBS MoneyWatch columnist Larry Swedroe explored how fast global markets respond to breaking news. Pointing to evidence from a number of studies among several developed markets, the universal response was nearly instantaneous price-setting during the first handful of post-announcement trades. In the U.S. markets, it was even faster than that.

News travels quickly, and prices can adjust in an instant. For Example, in the image below, the change in Berkshire Hathaway’s shareprice can be seen immediately after the purchase of Heinz is announced.

 

 

 

In other words, unless you happen be among the very first to respond to breaking news (competing, mind you, against automated traders who often respond in fractions of milliseconds), you’re setting yourself up to buy higher or sell lower than those who already have set new prices based on the news – exactly the opposite of your goal.

 

Your Take-Home

Rather than try to play an expensive game based on ever-changing information and cut-throat competition over which you have no control, a preferred way to position your life savings is according to a number of market factors that you can better expect to manage in your favor. In future Evidence-Based Investment Insights, we’ll introduce these factors to you.

 

But first, you may be wondering: Even if you aren’t personally up to the challenge of competing against the market, you may think you can select a pinch-hitting expert to compete for you. Next up, we’ll explore the strikes against that tactic as well.

 

Evidence-Based Investment Series #3: Financial Gurus and Other Unicorns

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

You, The Market, and The Prices You Pay

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Have you ever heard the expression: Together, we know more than we do alone.

It is simple and powerful. It also describes the market, really well.

 

You, the Market and the Prices You Pay.

When it comes to investing (or anything in life worth doing well) it helps to know what you’re facing. In this case, that’s “the market.” How do you achieve every investor’s dream of buying low and selling high in a crowd of highly resourceful and competitive players? The answer is to play with rather than against the crowd, by understanding how market pricing occurs.

 

The Market: A Working Definition

Technically, “the market” is a plural, not a singular place. There are markets for trading stocks, bonds, sectors, commodities, real estate and more, in the U.S. and around the globe. For now, you can think of these markets as a single place, where opposing players are competing against one another to buy low and sell high.

 

Granted, this “single place” is huge, representing an enormous crowd of participants who are individually AND collectively helping to set fair prices every day. That’s where things get interesting.

 

 

Group Intelligence: We Know More Than You and I

Before the academic evidence showed us otherwise, it was commonly assumed that the best way to make money in what seemed like an ungoverned market was by outwitting others at forecasting future prices and trading accordingly.

 

Unfortunately for those who are still trying to operate by this outdated strategy, a simple jar of jelly beans illustrates why it’s an inherently flawed approach. Academia has revealed that the market is not so ungoverned after all. Yes, it’s chaotic, messy and unpredictable when viewed up close. But it’s also subject to a number of important forces over the long run.

 

One of these forces is group intelligence. The term refers to the notion that, at least on questions of fact, groups are better at consistently arriving at accurate answers than even the smartest individuals in that same group … with a caveat: each participant must be free to think independently, as is the case in our free markets. (Otherwise peer pressure can taint the results.)

 

Writing the Book on Group Intelligence

In his landmark book “The Wisdom of Crowds,” James Surowiecki presented and popularized the enormous body of academic insights on group intelligence.

 

Take those jelly beans, for example. In one experiment, 56 students guessed how many jelly beans were in a jar that held 850 beans. The group’s guess – i.e., the aggregated average of the students’ individual guesses – came relatively close at 871. Only one student in the class did better than that. Similarly structured experiments have been repeated under various conditions; time and again the group consensus was among the most reliable counts.

 

 

Now apply group wisdom to the market’s multitude of daily trades. Each trade may be spot on or wildly off from a “fair” price, but the aggregate average incorporates all known information contributed by the intelligent, the ignorant, the lucky and the lackluster. Thus the current prices set by the market are expected to yield the closest estimate for guiding one’s next trades. It’s not perfect mind you. But it’s assumed to represent the most reliable estimate in an imperfect world.

 

Your Take-Home

Understanding group intelligence and how it governs efficient market pricing is a first step in more consistently buying low and selling high in free capital markets. Instead of believing the discredited notion that you can regularly outguess the market’s collective wisdom, you are better off concluding that the market is doing a better job than you can at forecasting prices. Your job then becomes efficiently capturing the returns that are being delivered.

 

But that’s a subject for a future Evidence Based Investment Insights. Next up, we’ll explore what causes prices to change. Chances are, it’s not what you think.

 

Evidence-Based Investment Series #2: Ignoring The Siren Song Of Daily Market Prices

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

What is Evidence-Based Investing?

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What is Evidence-Based Investing???

Evidence-based investing is an approach to investing that seeks to participate in the available global markets in a low cost and highly diversified manner.  More than any other approach, we feel this method of investing rigorously incorporates the best available information on how markets have delivered long-term wealth to patient investors.  Many investors may be familiar with terms such as “passive” or “index” investing, and it’s becoming easier for individual investors to gain cost-effective exposure to globally diversified market returns. – An evidence-based investing approach incorporates many strengths of passive/index investing, while eliminating some of its inherent weaknesses, and incorporating a focus in investment areas that have demonstrated potential long-term advantage.

 

A Brief History of Indexing

To understand how evidence-based investing works today, it’s helpful to review where it came from. Before there was any form of passive investing, there was active investing. Active investors try to profit by predicting where and when they’re going to experience future gains and losses, and proactively trade in and out of securities, sectors or markets to stay one step ahead. While the idea may seem appealing, there are reams and decades of academic evidence demonstrating that the tactic simply doesn’t reliably work, especially after factoring in costs.

 

In the early 1970s, the first index funds were formed to offer investors a better choice. As the name implies, an index fund buys and holds the securities tracked by a particular index, which is seeking to reflect the performance of a particular asset class. For example, the earliest index funds tracked the popular S&P 500 Index – which in turn tracks the asset class of U.S. large-company stocks. Over time, additional index funds (and similar Exchange Traded Funds, or ETFs) have emerged to track a host of other indices, representing a wide range of asset classes.

 

Many index funds are well-suited alternatives to actively managed funds, offering tighter control over the actions that academic evidence indicates are critical to expected outcomes:

 

Asset allocation – How you allocate your portfolio across various market asset classes plays a far greater role in varying your long-term portfolio performance than does the individual securities you hold.

 

Global diversification – Through broad and deep diversification, the sum of your whole risk can actually be lower than its individual parts.

 

Cost control – The less you spend implementing a strategy, the more you get to keep.

 

Inherent Weaknesses in Index Investing

So far, so good. But there are at least a couple inherent weaknesses to index funds.

 

Index Dependency – Most index funds are generally cost-effective compared to active strategies. But, by definition, they track an index. Whenever that index “reconstitutes” by changing the underlying stocks it is following, the funds tracking it must do so as well – and quickly. In a classic display of supply-and-demand pricing, this generates a buy high, sell low environment as index fund managers must queue up to simultaneously sell stocks that have been removed from the index and buy stocks that have been added.

 

Compromised Composition – Asset class investing is based on the premise that particular market asset classes exhibit particular return characteristics over time. For example, academic evidence has demonstrated that the stocks of distressed, small-companies are perceived as riskier than stocks of thriving, large-companies. So investors demand – and have by and large received – a premium return for investing in these riskier factors.

 

An index seeks to accurately proxy the asset class it is targeting. But it’s still just a proxy. The S&P 500, for example, tracks only 500 U.S. large company stocks out of the more than 16,000 large companies counted in the 2010 U.S. Census. Tracking an index enables pretty good exposure to a targeted asset class, but there’s room for improvement by a fund manager who can capture a larger, more accurate representation of the asset class being targeted.

 

The Advancement of Evidence-Based Investing

It didn’t take long before academically minded innovators from around the globe sought to improve on the best traits of index funds and eliminate their weaknesses. In fact, many of these thought leaders were the same early adapters who introduced index fund investing to begin with. The results are evidence-based investment funds, which offer us several advantages:

 

Index-independence – Evidence-based fund managers have freed themselves from tracking popular indexes. Instead, they have established their own parameters for cost-effectively investing in the lion’s share of the securities within the asset class being targeted. This reduces the need to place undesirable trades at inopportune times simply to track an index; it allows them to employ more patient trading strategies and scales of economy to achieve better pricing.

 

Improved Concentration – Untethering themselves from popular indexes also enables evidence-based fund managers to more aggressively pursue targeted risk factors; for example, an evidence-based small-cap value fund has more flexibility to hold smaller and more value-tilted holdings than a comparable index fund. This provides us with more refined control as we construct clients’ portfolios according to their individual risk/return goals.

 

Focusing on Innovative Evidence – We firmly believe that investors are best served when we make it a top priority to heed the evidence on how markets have delivered long-term wealth. Evidence-based investing shifts the emphasis from tracking an index, to continually improving our understanding of the market factors that contribute to the returns we are seeking. By building portfolios using fund managers who apply this same evidence to their fund constructions, we feel we can make best use of the academic insights we already know, while efficiently incorporating credible new ones as they emerge.

 

A Final Word: Investor Behavior

In many respects, the most important factor driving your investments has nothing to do with market factors. It has to do with your state of mind. To build or preserve sustainable wealth in ever-volatile markets calls for a disciplined outlook based on: (1) adhering to a long-term plan, (2) managing market risks and (3) minimizing the costs involved.

 

To help you achieve and sustain this challenging level of investment discipline, we take it as our honor and our duty to assist you in investing according to reason, based on the best available evidence on how markets work. That’s evidence-based investing.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.