Dedicated medical professionals like you, who are accustomed to the rigor of scientific methodology, may find the world of investment a tad different. Yet, there’s an investment approach that might just align with your love for evidence and research: Evidence-Based Investing (EBI). Here's a nuanced look into this approach.
Understanding EBI: Science Meets Finance
Evidence-Based Investing isn’t just a buzzword; it's about making financial decisions grounded in empirical evidence, primarily from extensive financial market research. Like in medicine, where treatments are based on rigorous research and clinical trials, EBI relies on comprehensive research and empirical evidence.
The Pillars of EBI
- Diversification: A diversified investment is like not putting all your eggs in one basket. As John C. Bogle mentions in The Little Book of Common Sense Investing, "Don't look for the needle in the haystack. Just buy the haystack!" – emphasizing the value of broad market index funds.1
- Market Efficiency: Current stock prices are believed to reflect all available information. As Burton Malkiel illustrated in A Random Walk Down Wall Street, stock prices are as unpredictable as the steps of a "drunken sailor" – and attempting to consistently outguess the market is futile.2
- Risk and Return: Understand that returns come with an associated risk. Higher potential returns often indicate a higher risk.
Diving into the Factors of EBI
Several factors, based on rigorous research, play pivotal roles in determining returns:
- Size: Historically, small-cap stocks have showcased different return patterns than large-cap stocks.
- Value: Stocks priced lower than their intrinsic value (value stocks) have historically shown distinct return behaviors.
- Momentum: Stocks have a tendency to continue performing in alignment with their recent performance.
- Profitability: Robert J. Shiller, in his work Irrational Exuberance, emphasized the cyclical nature of markets and the potential profitability during specific cycles.3
These factors echo the groundbreaking "Fama-French Three Factor Model" by Eugene Fama and Kenneth French, which expanded the market return to include size and value factors.4
Interestingly, when we discuss market efficiency and the challenges of outperforming the market, the S&P Indices Versus Active (SPIVA) scorecard has consistently shown that a vast majority of active fund managers underperform their benchmarks. For instance, over a 15-year period ending in December 2019, 89% of U.S. equity funds underperformed their benchmarks.5
For medical professionals, transitioning from the evidence-backed realm of medicine to the volatile domain of finance might appear daunting. Yet, with Evidence-Based Investing, there's a methodical approach that mirrors your trust in research, facts, and empirical evidence. Embrace EBI, and embark on a well-informed, research-driven financial journey.
- Bogle, J.C. (Latest Edition). The Little Book of Common Sense Investing. Publisher.
- Malkiel, B. (Latest Edition). A Random Walk Down Wall Street. Publisher.
- Shiller, R.J. (Latest Edition). Irrational Exuberance. Publisher.
- Fama, E.F., & French, K.R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3-56.
- S&P Indices Versus Active (SPIVA). (2020). SPIVA U.S. Scorecard. S&P Dow Jones Indices.
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