What is Evidence-Based Investing?

Jan 31 2022 | Back to Blog List

A key part of our capital management approach here at Cedar Point Capital Partners is our focus on evidence-based investing, or EBI for short. But what does it mean to make “evidence-based” investment decisions? Shouldn’t all investments be made on solid evidence?

You might think so, but that’s not always the case in today’s financial industry.

Evidence-based investing, at its core, is about relying on empirical evidence, validated research and long-term historical data to make financial decisions, all with the goal of maximizing your risk-adjusted returns and minimizing your expenses.

It’s about making smart decisions for your money based on facts, rather than emotions, the financial press or a broker’s hype.

If that sounds sensible, or perhaps even obvious, that’s because it is. Evidence-based investing is really an old school investment strategy dressed up in new, trendy clothing: Invest your money in solid companies - stocks, bonds, or other financial instruments - and hold onto them as long as your time horizon allows.

Why evidence-based investing is better

This gets to the heart of EBI—we don’t think it’s better, we know it’s better, based on reams of published studies, research papers and analyses of historical investment performance.

Here are some of the investment facts we know to be true after decades of financial research:

• Markets are highly efficient and price in nearly all available information almost instantly, meaning your odds of “beating” or “timing” the market over the long term are slim.¹
• Funds with lower costs historically outperform those with higher costs.²
• Properly allocated assets (based on your risk tolerance) can both maximize your portfolio’s long-term returns and better protect your investments when one investment falls.
• Effective diversification can produce more consistent returns and reduce volatility through a global mix of investments.
• Periodic rebalancing of your portfolio is key to maintaining your return and risk targets.

We believe the advantage EBI offers investors is self-evident, and sometimes wonder why more financial firms don’t follow it—but the truth is that humans aren’t necessarily rational creatures. Investors are regularly swayed by the active manager with the golden touch, the Reddit boards with the hot stock picks, and the fear that comes from watching the Dow and S&P at their most volatile. People think they can beat the market or save their portfolios by buying and selling at just the right time.

It’s easy to get wrapped up in the emotions of the market, but research tells us that’s precisely when you lose the most money.

EBI can help us fight those human tendencies by offering time-tested principles that ground us in the market’s most manic moments. Have patience. Let the markets work. Don’t chase alpha.

We know that can be easier said than done at times, but that’s exactly what we’re here for. Call us today to discuss how we can help you build a solid, evidence-based foundation for your future.

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Citations:

1. Fama, Eugene F., Market Efficiency, Long-Term Returns, and Behavioral Finance (February 1997). Available at SSRN: https://ssrn.com/abstract=15108 or http://dx.doi.org/10.2139/ssrn.15108
2. Sharpe, William F., The Arithmetic of Investment Expenses (March 29, 2013). Financial Analysts Journal, Vol. 69, No. 2, 2013, Available at SSRN: https://ssrn.com/abstract=2241716

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