Embrace Evidence-Based Investing to Grow Your Wealth
Evidence-Based Investing: A Research-Backed Approach
Evidence-based investing stands in stark contrast to speculative hunches or arbitrary guesswork when it comes to managing investment portfolios. At its core, this investment strategy hinges on comprehensive research and the meticulous study of market behaviour over the long-term. Rather than relying on gut feelings or attempting to time the market, evidence-based investing centres around data-driven insights and observations. By delving into historical market data, trends, and patterns, investors can establish a robust foundation for making well-informed and prudent investment decisions. This method prioritises informed choices over impulsive reactions, seeking to navigate the complex financial landscape with a commitment to consistent growth and long-term financial success.
Active vs. Passive Investing: Choosing Wisely
Active investing revolves around a high level of engagement, involving frequent buying and selling of assets with the goal of surpassing market benchmarks. This approach relies on market timing, predictive strategies, and attempting to cherry-pick specific stocks or securities to outpace the market’s performance. Conversely, passive investing takes a different route, focusing on mirroring the returns of a particular index or asset class. By tracking established market indices like the FTSE-100 or S&P 500 in the US, passive investment strategies aim to replicate the overall market’s performance. Rather than banking on speculative forecasts or individual stock selections, passive investing benefits from the broader market movements, aligning with long-term growth and stability through well-diversified portfolios.
Why Passive Investing Often Prevails
Passive investing’s effectiveness stems from its simplicity and cost-effectiveness. Studies repeatedly show that over time, actively managed funds struggle to consistently outperform their benchmarks after fees. Passive investing, with its lower costs and focus on market returns, often proves to be beneficial for investors aiming for steady, long-term growth.
Is There Any Place for Actively Managed Funds in an Evidence-Based Portfolio?
This is where things get a little more nuanced and opinions differ. The evidence is clear — in most sectors, passive investing outperforms active investing over the long-term, but there are some niche investment areas and specialist mandates that could benefit from an active approach.
Consistent outperformance in large, developed investment markets (like the US and UK stock markets, for example) is almost impossible to do repeatedly. However, smaller, more niche sectors (smaller companies, for example) may provide active managers with more scope to use their skills and research to find undervalued stocks and deliver superior returns. The evidence is less clear here but still tends to favour the passive approach over the longer-term.
Where active managers do win out is in more specialist areas where passive investing is difficult or impossible. One example is property, a ‘bricks and mortar’ property fund requires a manager to select properties to buy and sell. Another example is so-called ‘absolute return’ funds where the manager seeks to provide investors with a positive return in all market conditions. These funds often use complex structured investments, private equity and derivatives amongst other strategies and typically require a fund management team to implement the strategy. The final area to highlight is ‘ethical’ or ‘sustainable’ investing. There are passive funds that have an ethical or sustainable mandate but active management can have merits here. Decisions about which stocks to include in such funds can be complex and may benefit from the oversight of an experienced management team and research by analysts. A final example to highlight is where investors require a higher-risk approach. As passive funds tend to track a specific market, there is often little scope to outperform the market as a whole. There may be times when investors are seeking a return higher than the market could deliver and are prepared to accept the risks that come with this. In such circumstances, an active fund could be used within a portfolio to add additional scope for potential outperformance.
Modern Portfolio Theory: The Science of Asset Allocation
Modern Portfolio Theory, a cornerstone in investment strategy, underlines the supremacy of asset allocation over the selection of individual securities. It underscores the importance of spreading investments across diverse asset classes, recognising that this diversity helps in navigating risks while striving for optimal returns. By distributing investments across various asset classes such as stocks, bonds, cash and commodities, investors aim to achieve a balance that aligns with their risk profile and financial objectives. The essence lies in crafting a well-structured portfolio, finely tuned to an investor’s tolerance for risk and their long-term financial aspirations. This strategic allocation not only delivers long-term returns but also acts as a safeguard, dampening the impact of market fluctuations and volatility to create a more stable investment journey.
Balancing Risk and Reward: Finding the Sweet Spot
The connection between risk and reward is fundamental to the investment landscape. It’s widely recognised that higher potential long-term returns are usually correlated with higher levels of investment risk, but an optimal portfolio aims to strike a delicate balance between the two. Evidence-based investing highlights this crucial balance, advocating for investment choices that align with an individual’s risk profile. This ensures the pursuit of investment growth while maintaining a level of risk within the investor’s comfort zone. The goal is to optimise returns while navigating potential market fluctuations with confidence and resilience.
The Importance of Regular Rebalancing
Empirical evidence suggests an important component of successful investment management is regular portfolio rebalancing. Over time, market fluctuations can cause the proportion of assets in a portfolio to deviate from the intended allocation. Regular rebalancing ensures that the portfolio realigns with its original asset allocation, mitigating risks and maintaining the desired level of diversification. This process involves selling overperforming assets and buying underperforming ones to maintain the target asset mix. Not only does rebalancing maintain risk levels in check, but it also forces a disciplined approach that often leads to buying low and selling high — an essence of investment success. Studies have shown that portfolios that are rebalanced regularly tend to exhibit more stable performance over time compared to those left unchecked.
The Impact of Charges on Investment Returns
The impact of costs on investment returns cannot be overstated. The charges tied to investing wield a profound influence on long-term returns. Numerous studies and research underscore the significance of minimising expenses, revealing that reduced costs usually translate into improved portfolio performance over the long-term. The compound effect of charges can slowly erode investment gains over time, making low-cost investing an attractive and prudent choice to safeguard and bolster the overall returns on investments.
Avoiding Market Predictions: Embracing Certainty
Predicting market movements or timing the market accurately remains a challenging feat. The fundamental principle of evidence-based investing revolves around a steadfast commitment to the long-term perspective, recognising the inherent unpredictability of short-term market fluctuations. This approach shuns futile attempts to outsmart or forecast the market, instead advocating for steadfast adherence to a sound, research-backed strategy. By embracing this mindset, investors can sidestep the pitfalls of trying to time the market and stay focused on a methodical, evidence-driven investment strategy that prioritises long-term growth and stability.
Constructing an Optimal Investment Portfolio
Research-backed investment strategies emphasise the crucial role of a carefully crafted, cost-effective portfolio. Building a diversified combination of assets, customised to align with an investor’s specific objectives and risk appetite, while minimising associated charges, has proven time and again to deliver exceptional long-term returns. This approach champions the idea that a thoughtfully designed, low-cost portfolio, combined with diversification across different asset classes, not only amplifies potential gains but also guards against unnecessary expenses that could otherwise eat into overall investment performance over time.
Seeking Expert Guidance for Long-Term Wealth Growth
It’s possible for anyone to embrace evidence-based investing. With enough time, diligence and commitment, the long-term rewards will come. For others, navigating the intricacies of investment management can be overwhelming. A financial planner can create, recommend and manage a tailored investment strategy that is designed to achieve specific financial goals. Professional advice empowers investors to embrace an evidence-based approach, laying the groundwork for consistent and sustainable wealth accumulation over the long-term. Collaborating with a financial planner ensures that investment decisions are well-informed, aligning with an individual’s unique aspirations and risk profile to create long-term financial success.
The NorthStar Approach
At NorthStar Wealth Management, we are staunch advocates of evidence-based investing principles, both in constructing portfolios and in their ongoing management. Our investment philosophy is based on many years of empirical evidence and Nobel Prize winning research. We have developed a disciplined, risk-focussed process, taking the guesswork out of investing by using the very best scientific minds to help shape our investment strategy. Underpinning the NorthStar investment process is ‘Modern Portfolio Theory‘ and the ‘Capital Asset Pricing Model‘. These award-winning theories help us provide optimized, high-quality portfolios that deliver our clients’ investment objectives.
Our commitment to this approach is underscored by the consistent investment outperformance achieved over many years. We firmly believe that aligning portfolios with evidence-backed strategies, emphasising low-cost, diversified investments and taking a long-term view, have been instrumental in securing favourable returns for our clients. Our track record stands as a testament to the potency and effectiveness of adhering to evidence-based investing methods, ensuring that our clients benefit from well-founded, research-driven financial strategies. You can read more about our investment philosophy and learn more about our expertly crafted portfolios and the long-term performance achieved.
If you would like to talk about any of the issues in this article or need more general help with your finances, please get in touch with us.
Read this article on the NorthStar website.
