5 Key Tenets of Evidence-Based Investing

Evidence-based investing is an investment approach that emphasizes the use of academic research and empirical evidence to inform investment decisions. It aims to minimize biases and emotional reactions while focusing on long-term results. 

1. Diversification is Your Friend: The practice of spreading your investment across a wide range of assets, such as stocks, bonds, real estate, and other asset classes. By diversifying, you reduce the impact of any single investment's performance on your overall portfolio. This approach helps manage risk and increases the likelihood of achieving more stable returns over time.

2. Risk and Return are Interrelated: Asset allocation involves determining the proportion of your portfolio to allocate to different asset classes based on your risk tolerance, investment goals, and time horizon. Research has shown that asset allocation plays a significant role in determining portfolio performance, often outweighing the impact of individual security selection.

3. Costs Really Matter: Evidence-based investing advocates for keeping investment costs low. High fees, expenses, and taxes can significantly erode investment returns over the long term. Index funds and exchange-traded funds (ETFs) are popular choices for evidence-based investors due to their typically lower expense ratios compared to actively managed funds.

4. Markets Work: Evidence-based investing is based on the belief that markets are generally efficient. This means that asset prices quickly adjust to all available information, making it challenging to consistently outperform the market through active stock picking or market timing.

5. Structured and Disciplined Process: Evidence-based investing encourages investors to stay disciplined and maintain a long-term perspective. Rebalancing is the periodic adjustment of your portfolio's asset allocation back to its original target. Regular rebalancing ensures that you maintain your intended asset mix and can help buy low and sell high, taking advantage of market fluctuations. Avoiding emotional reactions to short-term market fluctuations and sticking to a well-thought-out investment plan can lead to better outcomes.

By adhering to these five key tenets, evidence-based investors aim to build portfolios that align with their financial goals, risk tolerance, and time horizon while staying grounded in a solid foundation of data and research.