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Over the past few months, we’ve spent a lot of time discussing evidence-based investing in our “Wealth Journey Investment Insights” series. Just like with any journey, we’d like to take a minute to look back where we’ve been.
If you missed any of these pieces, we’ve included a brief summary of each insight along with a link to the original article.
Using Group Intelligence For Buying Low And Selling High
The essence here is that “we” know more than “you” or “I” do. Groups arrive at approximately correct answers much more often and efficiently than individuals. This principle affects how markets are priced and reduces the likelihood that one person can beat the market.
In your financial journey, this means that when you use the sum of knowledge obtained by your guide, colleagues, and reference materials, you’re much more likely to carve a successful path for yourself than you would alone.
Why Financial Market Prices Change & Why You Should Care
The key here is that any individual is extremely unlikely to react to changing market conditions faster than the market itself. The competition is stiff, well-armed, and always evolving.
Prices change for a variety of reasons, but you should invest according to a set of principled factors, not breaking news.
What To Do With A Unicorn
Everyone would like to have a “guy” who will help them beat the market. But research has shown that active managers, by and large, cannot and do not consistently beat the market.
This ties back to our first idea, that groups know more than individuals. That “can’t-miss expert” is an individual trying to pull one over on the group. Yes, they might find short-term wins in some cases, but on the whole, it’s a losing game.
Managing The Market’s Risky Business
There are two types of risk: avoidable, concentrated risks and unavoidable market risks. Concentrated risks can be minimized by diversifying assets to ensure that no single entity takes down the entire portfolio. Market risks are those that we as investors must take on to see any significant return.
Every journey has pitfalls, but proper planning and guidance can help avoid the obvious ones.
The Full-Meal Deal Of Diversification
Diversifying doesn’t only mean having a bunch of different assets – it involves having many different kinds of assets.
The goal is to spread risk around. Done correctly, diversification can dampen exposure to several investment risks while improving expected returns.
How Does The Market Work?
When an investor sees a return from the market, it might be because a particular stock went up or down, but there’s more to it. Investors provide capital to the enterprise to keep it moving.
It’s important to remember that returns don’t always equal company success. Returns are determined by countless factors, but first and foremost among them is exposure to market risk.
Diversifying for a Smoother Ride
Diversification helps minimize the sharp climbs and declines an investor might experience. When the risk load is shared across many assets and sectors, the portfolio as a whole is less likely to suffer when one portion falls behind.
It can also reduce the need for moving in and out of positions that become unfavorable. While one portion of the portfolio struggles, another may rally.
The Essential Factors In An Evidence-Based Portfolio
Sixty years of evidence points to three key factors in the stock market and two for bonds that form the backbone of evidence-based portfolio construction.
New Factors For An Evidence-Based Portfolio
Three-factor investing has not solved the market riddle. There are ever more factors being identified and patterns being recognized.
Profitability and Momentum are among newer factors being discussed and employed by investors. As with anything new, their theory and implementation may not yet be perfected and may still produce unpredictable results.
Don’t Listen to Your Gut
Above all, investors may find their own instincts and snap decisions regarding market events the toughest hill to climb.
Behavioral finance seeks to understand these reactions and devise methods of avoiding costly “intuitive” errors.
Mastering Behavioral Biases
Here we dive deeper into behavioral finance, discussing six deep-seated instincts that may fool you into making unwise decisions.
In these situations, having a guide who understands the internal pull and how to navigate it is critical to continued success.
The Whole Picture
We’ve reached the peak. This is the summit of our Evidence-Based Investing mountain. Now that you’re here, we’d like to share the three key insights we believe will make you a more confident investor:
1. Understand the Evidence.
You don’t need to be a professional mountain climber to make a tough hike. You just need to follow the advice of those who’ve made the climb themselves and have helped others.
It’s the same for your financial journey. Find a guide you trust who knows how to navigate the terrain you’re facing.
2. Embrace Market Efficiencies
You don’t have to be smarter, faster, or luckier. You only need to structure your plan to go with the lay of the land, not against it. Understand your map and follow your path.
3. Manage Your Behavioral Miscues
You won’t be able to avoid every emotional situation, be it a high or a low. Just try to remember that your instincts will tempt you to change course at some point. Your best defense in such circumstances is a plan.
Your guide can be a helpful ally in keeping you on the straight and narrow.
I hope this series has given you a better understanding of the many facets of your financial journey. It may seem pretty scary at times, but it can be quite rewarding and peaceful if you approach it with the evidence on your side.
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