I did an interview with ETF.com on Evidence Based Investing. Here is a short excerpt:
ETF.com: Evidence-based investing is essentially the opposite of behavioral investing?
Ritholtz: It’s making decisions based on things that we know are factually true.
Some of evidence-based investing is, “We know at the root that people aren’t really rational, profit-maximizing machines, despite what a lot of economic theories suggest.” So a big part of evidence-based investing is understanding where we get in our own way.
The thing we really like about factor-based investing is historically the data shows that if the holdings you have have a bias toward small-cap, toward cheaper valuation, toward high quality over long periods of time, you’ll likely do better than the market, because history shows us that stocks with those characteristics, on average, statistically tend to outperform the benchmark.
That sort of data analysis is part of what evidence-based investing is. And there are many flavors of it; it’s not just factor investing.
ETF.com: Is the goal to generate persistent alpha where active managers are failing?
Ritholtz: The assumption that’s automatically built in to a lot of the world of investing is, “I must pursue alpha; I must beat the market.” To do that, I’m going to take more risk or pay a little more.
One of the first steps in evidence-based investing is asking these simple questions: Why are you investing? What goals do you have? Do you need to assume more risk to achieve your goals?
We all want to do better than average, but sometimes you have to say, “Here’s beta; that’s a sure thing. All the data says odds are that very few people do that over three years; even less do it over five years.
The trade-off often is that you’re assuming more risk, more volatility, and the odds are that you’re not only not going to get alpha, you’re not even going to get beta. Evidence-based really means unpacking questions and asking really broad, fundamental thoughts on what we’re really looking for.
Understanding Evidence Based Investing
ETF.com, November 01, 2017