Note: I will be attending the terrific Evidence-Based Investing Conference on November 15, 2016 in New York. You should too.There is a new and growing movement in our industry toward so-called evidence-based investing (which has much in common with evidence-based medicine). As Robin Powell puts the problem, “[a]ll too often we base our investment decisions on industry marketing and advertising or on what we read and hear in the media.” Evidence-based investing is the idea that no investment advice should be given unless and until it is adequately supported by good evidence. Thus evidence-based financial advice involves life-long, self-directed learning and faithfully caring for client needs. It requires good information and solutions that are well supported by good research as well as the demonstrated ability of the proffered solutions actually to work in the real world over the long haul (which is why I would prefer to describe this approach as science-based investing, but I digress).
The obvious response to the question about whether one’s financial advice ought to be evidence-based is, “Duh!” Then again, investors of every sort – those with a good process, a bad process, a questionable process, an iffy process, an ad hoc process, a debatable process, a speculative process, a delusional process, or no process at all – all think that they are evidence-based investors already. They may not describe it that way specifically. But they all tend to think that their process is a good one based upon good reasons. Nothing to see here. Move right along.
Nearly as problematic is the nature of evidence itself. The legal profession has been dealing with what good and relevant evidence is for centuries. According to the Federal Rules of Evidence (Rule 401): “Evidence is relevant if: (a) it has any tendency to make a fact more or less probable than it would be without the evidence; and (b) the fact is of consequence in determining the action.” That’s a really low bar, which explains why so much more than merely evidence is implicit within the rubric of evidence-based investing.
And therein lies the problem. Committing to an evidence-based approach is a great start, a necessary start even, to sound investing over the long-term. But it’s not enough…not by a longshot. As philosophers would say, it’s necessary but not sufficient. Most fundamentally, that’s because:
- The evidence almost always cuts in multiple directions;
- We don’t see the evidence clearly; and
- We look for the wrong sorts of evidence.
I’ll examine each of these related issues in turn. Continue reading