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Evidence Based Investing

Bigwig only offers Exchange Traded Funds (ETF's). Why? Because the evidence is overwhelming that low cost index tracking investments deliver better investment results over long periods than does stock picking or active funds. There is a lot of science behind Evidence Based Investing (EBI). Here is a bit of a primer.

There are 5 concepts that are important features of EBI;

  1. Markets are generally efficient - that means that information about companies is available to the broad market and that it has been factored into the price of securities. that really true? I'll come back to this one.

  2. There is a relationship between risk and return. This is about uncertainty. If we all know with 100% certainty that company A is going to make a squillion out of widgets the market would have priced that in already and there would be little risk and little return. It is the uncertainty that creates the volatility or risk and creates the potential for return. Generally speaking the higher the risk the higher the potential for both positive and negative returns.

  3. Diversification works. Investing in assets that are not highly correlated can reduce your risk and may not reduce your return. This makes sense when you think about it. If you buy two shares that move exactly together you are just going to get that return and that risk. But if you buy two shares which over time have the same return but don't move together then your portfolio will have the same return but will experience less volatility. So buying as many assets as you can (or an ETF that holds those assets) that all move in different directions for different reasons ends up reducing your overall risk.

  4. Costs matter. Fees on managed funds are maybe about 1% each year above fees on ETF's. Over time the cumulative impact of this is huge. So make sure you consider costs when investing.

  5. It is important to consider all of the above over the long term rather than the short term. In the short term markets will go up and markets will go down. If you can ignore that and use the concepts above then, over the long term, your investments will grow.

So thats the guts of EBI. There are hundreds of academic papers on each one of the points above and if you have the time, well, read them.

But let's go back up to point number 1. I don't really believe that markets are 100% efficient. That concept of market efficiency is super important in providing a framework for investing and markets don't need to be 100% efficient for EBI to work. If you are an absolute genius and you are prepared to dedicate all your time to analysing companies then maybe, just maybe you can pick a winner. If that's the case then go for it, pick stocks and good luck. For the rest of us even if markets are not 100% efficient we cant tell when they are and when they are not so let's not try.

So what does all this mean? It means, use well diversified index ETF's to build well diversified global portfolios - rebalance them occasionally, maybe once or twice a year, and then sit, wait and let time do the work. Your portfolio will grow. 3 or 4 ETF's combined in a way that gives you a risk profile you are comfortable with is all you need to create a sound, evidence based, global investment portfolio.

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