It wasn’t that long ago that evidence-based investing was a radical idea that flew in the face of the Wall Street establishment. It started as an underground movement, slowly gaining popularity as select institutions and small firms took the plunge and clients gained trust in a new approach. The foundation of this new trend was based on the Efficient Market Hypothesis (EMH) formulated in 1960 by University of Chicago Booth School of Business professor Eugene Fama. The premise states that because financial markets are very efficient at processing information, breaking news, or data that might affect the value of a company’s stock or bonds, they will quickly incorporate it into the price of those assets.
The price of a stock or bond reflects all public information available to investors at any given time, so it’s not likely to find a truly overvalued or undervalued investment. This is a big shift in thinking from traditional approaches to investing, which touted the undervalued investment as a means to getting rich. But it’s a myth. News that assumes revenues are going to grow is available to everyone. So everyone will act accordingly and make the same purchases, reflecting in the stock price. Essentially, it’s a level playing field because everyone has the same information. “Beating the market” is an outdated concept.
The term efficient market is a bit of a misnomer, as it isn’t perfectly efficient. Once in a while an investment may actually be undervalued for a period of time, so a quick move before the rest of the market catches on may yield some benefit. But it’s highly unlikely that any given investor (professional or amateur) will be able to take advantage of such inefficiencies on a consistent basis. Outguessing the market is risky and investors get it wrong more often then they get it right.
Evidence-based investing has taken the betting out of the process, relying instead on sound strategies that reflect the realities of the market. Investing in funds similar to index funds that target different areas of the market is a way to harness the growth of the global economy. The investor’s unique circumstances and the right mix of small company stocks, large company stocks, international stocks, etc., will help determine the plan. The key is to stick with it and let the financial markets do their job. A lower rate of activity saves money on brokerage fees and taxes, not to mention that it’s less stressful than trying to keep pace with fluctuations and short-term market swings.
Investment trends and theories come and go, but using data to build better portfolios is simply good business. The evidence speaks for itself.
This April, the Department of Labor issued its new fiduciary rule, which will require any advisor giving advice to retirement account holders to act in the client’s best interest. It certainly sounds like an obvious improvement, and we’re pleased to see some forward progress on this notion of a more global fiduciary standard. Remember, Hill Investment Group has been acting in the capacity of a fiduciary for our clients since the founding of our firm.
Nevertheless, we’re not all that hopeful to see newly minted fiduciaries taking on the title anywhere near its fullest extent. Their clients may be scratching their heads since surveys indicate that many already thought they had a fiduciary commitment from their advisor. In reality, they’ve been subjected to the suitability standard. It’s is far more common and gives a wide berth to advisors when defining what might be best suited for a particular client (think of high cost, proprietary, commission-based products).
Interested in additional reading on this topic?
Check out the endorsement from David Booth, Chairman and Co-Chief Executive Office of Dimensional Fund Advisors, that will appear on the book jacket. David rarely provides endorsements, so we’re honored to have him on board.
“Successful investing often comes down to having a strong philosophy you can stick with. In Odds On, Matt Hall shows how more than fifty years of modern finance have provided insight into how financial markets work. Investors who develop and apply a strong philosophy based on these principles can improve their odds of long-term financial success.”
*If you’ve pre-ordered the book but can’t wait any longer, the introduction and first chapter are now available for you to download here.
Watch for future updates coming your way about more incredible endorsements the book has received!