Evidence-based investing is the practice of grounding your investment strategy in a rational methodology backed by peer reviewed academic research. The goal of academic research is to find the truth about how capital markets really work, while the goal of Wall Street research is to sell you stuff. As fiduciary advisors, we don’t work on commission, so we don’t care about what sells. We care about what actually works as we build portfolios to help clients make the most of their one financial life. When we look at risk factors in a portfolio, we:
- Assess a factors’ capacity to deliver expected returns and diversification benefits repeatedly.
- Understand why such factors exist, so we can assess whether they’ll persist.
- Explore additional factors that complement our structured approach.
Assessing the Evidence
Academic research has identified three long-term stock market factors:
- The equity premium
Stocks have returned more than bonds. Stocks are more volatile than bonds over the short term.
- The small-cap premium
Small-cap stocks have returned more than large-cap stocks. Smaller companies are more volatile than larger companies.
- The value premium
Value companies (low price to book stocks) have returned more than growth companies (high price to book stocks.) K-Mart is riskier than Walmart.
Similarly, academic research has identified two key factors driving bond returns:
- Term premium – Longer dated bonds have returned more than shorter bonds (albeit with more volatility).
- Credit premium – Bonds with lower credit ratings have returned more than bonds with higher credit ratings. Lower quality bonds entail more default risk.
Caution: targeting premium returns involves engaging more risk so effective diversification is crucial.
Understanding the EvidenceEvidence – based investors strive to determine not only that various return factors exist, but why they exist. This helps us determine whether they will persist such that we can capture them in a client’s portfolio. The key is to consider all of these powerful risk/return factors in creating a portfolio aligned with your particular goals and circumstances. The goal is to help you make the most of your one financial life. That’s what we do.
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Brian Puckett “Don’t you deserve a fiduciary advisor that puts your interest first and backs it up in writing? Call now for your FREE consultation.” (727) 455-0033
Story by by Brian Puckett, JD,CPA,PFS,CFP® AlignMyWealth.com