What is Evidence-Based Investing?
You may or may not have heard of “evidence-based investing,” but as an investor, it’s a term you should become familiar with. This investment approach differs from typical strategies in several important ways and can offer significant benefits for investors.
The following are a few frequently asked questions about evidence-based investing to help you better understand this approach and how it compares to other investment strategies.
What is evidence-based investing?
Evidence-based investing takes a less subjective, more disciplined approach to investing. This approach is grounded in economic theory based on understanding the investment best practices and body of knowledge defined by decades of peer-reviewed academic research.
An evidence-based approach to investing focuses on what each investor can control, emphasizing diversification and minimizing expenses and taxes when possible. Taking an evidence-based approach means trusting markets to do what they do best, which enables investors to understand and stick with their investment strategy, even in challenging or turbulent market environments.
There are six key tenets associated with our evidence-based investing approach at Kaufman Rossin Wealth:
- Control what you can.
- Global stock market diversification is the starting point.
- Size, value, and momentum tilts can increase expected return.
- The primary role of fixed income is to reduce volatility.
- Academic evidence supports modest use of alternative investment strategies.
- Evidence-based investing slowly evolves over time.
How does evidence-based investing compare to other investment approaches?
Many investors (and investment managers) talk about “beating the market,” picking the best stocks, and timing the market to generate the best returns. This active investment approach may involve looking at fluctuations in asset prices to decide when to buy or sell.
The primary difference between an active investment approach and evidence-based investing, is that in evidence-based investing, decisions aren’t based on current market trends or conditions; instead, investors turn to academic research, financial science and historical market data to guide their decision-making process.
Furthermore, evidence-based investing also generally emphasizes wider diversification, including investing in U.S., international and emerging market stocks, not concentrating solely on U.S. companies. Research shows that diversification across countries makes sense in much the same way as diversification across asset classes and companies.
Evidence-based investing also emphasizes a balanced approach to risk, using fixed income to reduce volatility. Importantly, evidence-based investing is not static. Investment strategy recommendations will evolve as academic and practitioner evidence evolves.
Why should investors consider an evidence-based approach?
Research has shown evidence-based investment decisions can lead to an increase in expected long-term returns. For example, research has shown that small-cap stocks have generated higher long-term returns than large-cap stocks; value stocks have outperformed growth stocks; and positive momentum stocks have outperformed negative momentum stocks. Evidence-based investing tries to capture these long-term return premiums to give investors the best possible chance of generating returns equal to or better than the overall market.
Evidence-based investing may also incorporate alternative strategies that can enhance portfolio forward-looking return expectations and/or reduce portfolio volatility.
Contact me to learn more about Kaufman Rossin Wealth’s evidence-based approach to investing, and how it may be able to help you reach your long-term financial goals.
Charles Sachs, CFA, CFP®, is a Chief Investment Officer at Kaufman Rossin Wealth, LLC, a Registered Investment Adviser.