Science of Evidence-Driven Investing (BTS)
We offer a disciplined, unemotional, and highly diversified approach that offers objective advice rather than financial products to buy.
Most people think investing IS their plan! In fact, there is a lot of confusion between topics such as investing, planning, and even the difference between advisors! So let me provide some links to those differences first, and then get into the specifics of evidence-driven investing after that, simply to broaden your understanding of differences between these ... not all investing and not all advisers are the same ... there are differences you should understand so you are better educated to know what to look for and understand who you're talking with.
- What’s the difference between investing and planning?
- Is there a difference between advice and advisers?
- What’s the Difference Between Advisers?
What is a research based investing approach? Many firms talk about their research, but is it really research? What does research evidence REALLY look like?
So ... now that you've looks at what evidence really looks like, how is evidence-driven investing applied based on those principles? Decades have gone into academic research to answer the fundamental question: "Where do returns come from in the first place?" Below describes the application of answers from all that research.
From an early age, we’re taught that winning or beating the competition is good, but evidence-driven investing tells us that nothing could be further from the truth when it comes to investing.
Competing to win in this context – whether that’s running after a new investment tip or trying to time or guess the market ignores the reality that every other investor is doing the same - it's a zero sum game. It’s virtually impossible to consistently pick winning stocks that no one else has spotted and the performance of ‘star’ fund managers is often a string of luck, rather than true consistent and persistent skill. Playing this game incurs significant costs and encourages financial misbehavior, both of which can damage your long-term wealth.
Evidence-driven investing provides a structured and disciplined approach to portfolio construction that creates wealth by capturing the returns of the whole market, driving down costs and removing the emotional decision-making of a beat-the-market mindset. Markets go up and down and the magnitude of what your portfolio experiences can be managed. Of course, investing means taking risks; risks that may be mitigated through intelligent diversification and allocation that may narrow the range of gains and loss to focus on desired long term results (where I define long term as the rest of your life).
It is driven by the science of investing that cuts through the noise and confusion by focusing on what really drives investment return, helps reduce volatility, and simplifies the investment process. The time-tested core concepts of asset class investing are not new, supported from decades of evidence from academic research focused on answering the question “Where do returns come from?” However, these concepts tend not to be applied by active managers, which is what sets the approach apart.
With the above in mind, here’s a brief Big Picture on insights into what has gone into portfolio allocation behind the scenes … the why and the how:
The short article discusses “evidence driven.” What is Evidence-Driven Investing?
The science of Evidence-Driven investing has been applied by Dimensional since 1981. A short video (2:39) about Dimensional’s approach. I’ve applied this approach since 1999. Dimensional is one of my service partners who do the background behind the scenes work for people like you and me. I’m not obligated to use these service partners; I do because what they do is unique in combination.
The main objective is to apply the science, as briefly described here, to you specifically so that your money works as efficiently and as hard as it should for you.
After mentioning the “science” of investing – what does that science look like?
In brief … (examples via links) the principles of Modern Portfolio Theory, where diversification and optimization are diligently applied to your portfolios to put your money on the efficient frontier. Why? Because these are the best-known principles today that help you reach your goals by balancing risk with return across many academically identified and defined asset classes. [This paper brings these concepts together into an "efficient range" once investor behavior is considered too.]
A short description to look deeper into how that science is applied is described briefly below where I go over a general description how all the pieces, uncovered by decades of academic research, all fit best together. I call allocation the ingredients (asset classes), and diversification the recipe (formula to mix the same ingredients to get different results). For those interested in a deeper dive, here's an interactive step by step look into the financial science of evidence-driven application.
Few firms (especially retail firms marketing to the masses *) apply ALL of these math, statistics, financial science and evidence-driven principles to portfolio ingredients and allocation results so that results are personalized to have your money work as hard as it can for you and your PLAN **.
*For example, Vanguard only allocates for risk (allocation), but they do not take the optimization steps, as discussed above, to diversify. What’s the difference between Allocation and Diversification? They also use narrower market indexes which have limited exposure to index asset classes, whereas Dimensional isn't limited to retail index definitions, but broaden evidence-driven index definitions to capture more of the target asset class (explained more below).
**By the way, most people confusing investing with having a plan. Financial planning is about all those questions you have that do not involve investing. In other words, planning and investing are not the same thing (two analogies to illustrate the differences: Cables and the Bridge Fueling a Plane and Flying a Plane. Investing is nothing more than fueling your plan. You put fuel in your car. But what are you going to do with that car? Where do you intend your car to take you? Where's your Google map to get there? What is your financial plan? Where do you intend your investments (fuel) to take you?
Where's your financial plan (Google map) to get there?
Below are the main investing concepts that are applied based on the above insights. Other pages on this site discuss the planning concepts applied to your unique situation.
A cornerstone concept of modern economics is that a free and competitive market system is the most efficient way to allocate resources. Securities markets throughout the world have a history of rewarding investors for the capital they supply. Companies compete for investment capital, and millions of investors compete with each other to find the most attractive returns.
This competition quickly drives prices to fair value, ensuring that no investor can expect greater returns without taking greater risk. The result is an efficient market system with prices that incorporate all available information as well as future expectations, and are the best approximation of fair value.
We attempt to capture market rates of return by using institutional mutual funds that invest in thousands of securities in selected asset classes. These funds exclude financially distressed and bankrupt companies as well as illiquid securities and Initial Public Offerings. They also minimize trading costs through a patient and flexible trading approach that does not mandate index tracking like traditional index funds and ETFs.
We believe that investment returns are primarily determined by risk. We help our clients manage their portfolio’s risk and return profile by allocating money to asset classes with risk factors from decades of evidence that may have higher expected returns over the long run (which we define as the rest of your life, since our planning focus is on retirement planning, which is not short term).
The equity risk factors we target in our portfolios include momentum, value, size, profitability, term, and credit. We tilt portfolios to these risk factors to adjust risk based on a client’s risk tolerance, financial goals and other considerations. Why combining these factors is also important.
We combine the equity portion of a portfolio with short term fixed income to further manage risk and create a risk-adjusted portfolio.
Diversification is much more than the idea of not putting all your eggs in one basket. An effectively diversified portfolio is constructed of securities, or preferably entire asset classes, that do not share common risk factors and therefore tend not move together. It has components that may zig while others zag, creating more consistent, less volatile returns that compounds money at a greater rate than a more volatile portfolio with the same average return.
To accomplish this we combine asset classes in a portfolio that have dissimilar return patterns. We invest globally across thousands of securities to minimize single-security risk and to capture the diversification benefits of different country markets and currencies. We also combine equities with high-quality, short-term fixed income securities that have a low correlation with stocks.
Diversification and allocation are not the same thing.
The video is a generic explanation that I have chosen not to make it appear that I have produced it. It was produced by Robin Powell in the UK for adviser use. It is meant to summarize the above points using different words and concepts. What does the last point in the video "Invest for the Long Term" mean? It means for the rest of your life.
We use a comprehensive tax management approach to help minimize tax exposure for our clients. Our goal is to maximize after-tax returns while maintaining a client’s desired target risk level.
Over time, a portfolio will drift from its initial asset allocation due to market fluctuations, changing the portfolio’s risk and return characteristics. Rebalancing brings the portfolio back closer to its original risk adjusted targets, helping to retain its risk profile (the primary objective) by buying those asset classes that are underweight and selling those that are overweight. Rebalancing may also aid overall risk adjusted portfolio returns (the secondary objective) by taking advantage of market fluctuations over time.
More details on how the above is accomplished in practice with consistent Evidence-Driven Principles and Philosophy:
Evidence-Driven Investing powering personalized financial planning unique to you.
Real evidence is global ... it works everywhere ... Malkiel's "Random Walk Down Wall Street," summarized here with 6 principles, also summarizes the points above and is the basis in the Evidence-Driven Investing link as well.
This philosophy and process eliminates prediction- and speculation- based investing. How do you consistently and persistently GET market returns? By being the market through indexing, not trying to beat the market. Values go up and down, and you don't lose money until you sell low ... so don't sell low! Investing is about accumulating and shepherding numbers of shares. Share values go up and down (like the value of your house). When you run out of shares is when you run out of money. Be comfortable when markets go down, and invest for the long term, which is for the rest of your life (that's the definition of retirement, isn't it?), for those long term gains. The past doesn't predict the future, but it echoes (“History doesn't repeat itself but it often rhymes,” Mark Twain).
Pursuing a Better Investment Experience - 10 Key Principles DFA
How are ALL of the above all connected together? Big picture summary: Key Points for investors from the foundational firm (Dimensional) that both academically researches where and how to invest, and then applies those empirical results cost effectively.
Contact us today to find out more about my financial planning process and learn how a sound plan can help you achieve your goals.