What is Evidence-Driven Investing™?

Simply put, investing based on evidence is like using a GPS for a road trip. Just as you rely on the GPS to guide you using real-time data and proven routes, evidence-driven investing relies on historical data and established financial principles to make informed decisions about how to invest your money.

Evidence-based investing takes the guesswork out of the equation using empirical research and data rather than relying on someone’s hunch, opinion, intuition, or market prediction. This approach is well known for its clarity and reliability. 

As financial advisors in Chicago and St. George, we firmly believe in using an evidence-based approach for our clients’ investment portfolios. In this blog, we’ll explore evidence-driven investing in more detail.

Do You Have a Crystal Ball? 

Unless you have a crystal ball, trying to outperform the market year in and year out requires precise predictions about market movements and impeccable timing. This is nearly impossible due to the unpredictable nature of what drives the performance of the financial markets. The evidence is overwhelming that even seasoned professionals often lack skill in forecasting market fluctuations accurately.

No one is very good at consistently getting the market forecasts right. When it comes to market predictions, anything can happen. In fact, the only value in market strategists’ forecasts is that they show many outcomes are possible. The S&P 500’s performance is a case in point. At the start of 2023, the predictions of 23 analysts from leading investment firms ranged widely. Some thought the index would end the year down 5%, others up 24%, and the average forecast was for it to end up 6%. Defying these expectations, it closed the year up 26.4%, a surprise for many, especially those who expected 2023 to be a difficult year for investors. The lesson for investors is to tune out predictions. 

Independent research indicates investment managers are no better at picking stocks or sectors to outperform benchmark indices than they are at forecasting. Over long periods, approximately 10% of conventional funds surpass benchmark market rates of returns after deducting expenses. After taxes are considered, it is even much less.

Another drawback of this strategy that many don’t consider is the trading costs associated with market timing (moving money in and out of the markets). Turnover, resulting in trading costs such as brokerage fees, bid-ask spreads, and market impact, can be just as large as a fund’s expense ratio, negatively impacting performance. If not managed correctly, this strategy can also result in significant capital gains taxes, further diminishing your returns after expenses and taxes.

This strategy also demands constant monitoring of market conditions, which can be time-consuming and stressful. This can distract you from pursuing your long-term financial goals and lead to reactive, emotion-driven decisions, often resulting in poor investment performance.

Watch our founder, Michael Evans, discuss how working with an objective financial advisor can make a difference.

The Origins of Evidence-Based Investing

Harry Markowitz introduced the concept of diversification to minimize risk while maximizing returns in the 1950s. His modern portfolio theory (MPT) won him a Nobel Prize. This theory laid the groundwork for evidence-based investing, which uses statistical evidence to make informed investment decisions.

Evidence-driven investing reduces or eliminates the influence of making investment decisions solely based on emotions and speculative risks. It focuses on diversification, low costs, and tax efficiency, ideally aligning your investment strategies while pursuing long-term financial goals. 

This approach also uses peer-reviewed academic research and empirical evidence, helping you to make informed decisions and focus on factors within your control, such as investment costs, tax efficiency, and risk exposure.

Evidence-driven Investing™ contrasts sharply with more speculative strategies that often rely on market timing or predicting future events, the crystal ball again, which are notoriously unpredictable.

By analyzing patterns, trends, and anomalies within vast datasets, an evidence-driven strategy seeks to identify investment opportunities with a higher probability of success based on historical performance.

Risk Management Benefits of Evidence-Driven Investing™

To optimize your investment returns while minimizing your exposure to unnecessary risks, you should consider evidence-based investing: 

  • Because you are using data to make informed decisions based on proven investment principles, you greatly reduce your risk of making decisions based more on emotion, speculation, or what you may see in the media.
  • Diversification becomes a key component of your investment strategy as you utilize various asset classes to reduce the impact of market volatility on your overall portfolio. 
  • Investing in a broad range of asset classes and individual investments reduces your risk of large losses from a single class or investment. 
  • Evidence-based investing also helps you stay focused on a long-term perspective rather than trying to capture short-term market movements. This long-term focus helps avoid the costs and risks associated with attempting to predict short-term market movements, which are often unpredictable and can lead to increased trading costs and the potential for loss.

Cost Efficiency of Evidence-Based Investing

Evidence-based investing typically involves lower costs compared to other investment strategies, mainly due to the following factors: 

  1. Evidence-based investing often relies on index funds or other passive investment vehicles, which generally have lower expense ratios than actively managed funds. This is because active management requires more day-to-day research, analysis, and frequent trading, all of which add to costs and reduce returns.
  1. Evidence-based investing tends to have lower turnover rates. Active strategies often involve frequent buying and selling securities to capitalize on short-term market opportunities, which can result in higher transaction costs and tax implications for investors. In contrast, evidence-based approaches are more about building a diversified portfolio for the long term and minimizing these costs.
  1. Lastly, evidence-based investing can harness the market’s natural growth over time, reducing the need for constant trading and the associated costs. On the other hand, active strategies attempt to outperform the market, which incurs higher costs and introduces greater risk and uncertainty.

Consider working with a Chicago fee-only financial advisor who advocates for Evidence-Driven Investing™. 

The Role of Technology

Given recent technological advancements, Evidence-Driven Investing™ now allows advisors to use funds from managers to analyze data faster and more accurately than ever before. Sophisticated algorithms and software can sift through decades of market data to identify trends and patterns that have the potential to produce improved investment returns. These factors must be robust, persistent, and implementable. 

Choosing an Fee-Only Fiduciary Financial Advisor 

As someone who has accumulated significant wealth, working with a fee-only fiduciary advisor in Chicago can offer several clear advantages for you. The choice often boils down to finding a professional who understands the Evidence-Driven Investing™ approach and is disciplined enough to practice it. 

  1. A fee-only structure aligns the advisor’s interests with yours. Advisors are compensated solely through direct fees from clients rather than commissions from third parties. This means their advice focuses on what’s best for you rather than generating commissions for themselves.
  1. A Chicago fiduciary advisor is legally bound to act in your best interests. This commitment ensures that your investment strategy is designed with your financial goals and risk tolerance at the forefront. This legal obligation provides protection and reliability in the advisor-client relationship.
  1. Evidence-based investing relies on empirical research and historical data rather than market speculation. A fee-only fiduciary advisor in St. George will utilize this approach to craft a well-informed and disciplined investment strategy for long-term growth and stability.
  1. Your financial advisor should be fully transparent about their methods, willing to discuss the data that supports their strategies, and act as fiduciaries, putting your interests first.
  2. The advisor you choose should also invest their and their firm’s retirement plan assets in the same evidence-based manner as they recommend to you. 

Ready to learn more about our Evidence-Driven Investing™? Let’s connect for an introductory meeting.

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