Does your investment portfolio have these five hallmarks of being evidence-based?
I spent the first 10+ years of my career as a consultant to the investment teams of several of Canada’s largest pension plans. These organizations have access to incredible talent, scale, and cutting edge research. They hire teams of the best and brightest, and work hard to deliver a globally diversified portfolio with slightly enhanced risk-adjusted returns — net of the costs of all those smart people & technology. While there have been some recent challenges, it’s still a model that intuitively makes sense: world class investment managers, with massive scale, working on behalf of their members, without a profit motive.
Unfortunately, most individuals don’t have the option to invest their full savings alongside the $200 Billion+ behemoths like PSP, OTPP, or CPP Investments.
Over the past few years I’ve delved into the research on what investment approaches work best for individual investors and the good news is that excellent returns don’t require pension level knowledge, scale, expertise, or complexity.
The more I learn, the more I am convinced that for long-term individual investors a simple, passively managed, low-cost, globally diversified, portfolio with an appropriate asset allocation is ideal in the vast majority of cases.
As a reminder this blog is intended as general education and is not investment advice.
I’ve summarized what I’ve learned into five hallmarks of an evidence-based investment approach:
1) Simple—> As few moving parts as possible. The more moving pieces and complexity the more trades and decisions that need to be made both in rebalancing and investing new contributions. It’s extremely difficult to beat the market, so each time an investor tinkers with their portfolio they’re likely to lose a little (or a lot). Fewer moving pieces (all else equal) leads to performance that stays closer to the market, and market performance is pretty remarkable! This might literally mean holding a single exchange traded fund or low-cost mutual fund in your portfolio.
2) Passively Managed—> Not trying to beat or time the market. This applies at two levels. #1) In the funds that you invest in: There is evidence of skill amongst the most skilled investment managers; however it’s nearly impossible to identify that skill in advance, and the fees those managers charge (to retail investors) tend to eliminate any outperformance, so you are better off not paying someone to try and beat it and instead owning the market through an broad index fund. #2) In how you engage with your investment portfolio, even passively managed funds can be used to time the market in an active way (think selling your holdings when there are scary news headlines). Again each change you make is a gamble against the really smart people who make up the market. There is some evidence supporting factor based investment approaches (e.g. Value & Size) but these should be systematically applied to a portfolio that still has broad market exposure.
3) Low-Cost—> Less than 0.5% for investment management implementation. As discussed in a previous post, costs can significantly impact your long-run investment outcomes. For many people paying for advice including financial planning can be very valuable (quantitatively and qualitatively), but that should be considered separately from the cost of pure investment implementation which should be less than 0.5% (and often ~0.2%).
4) Globally Diversified—> Holding the whole global market. Diversification is the only “free lunch” in investing: higher expected returns without increasing the level of risk. Broad diversification across many geographies and size of companies and individual holdings helps smooth out the ride. By casting a broad net you are more likely to catch the winners (and the losers but that’s ok) and the winners tend to drive overall market performance.
5) Appropriate Asset Allocation—> A personalized mix of stocks & bonds. This is probably the most important decision an investor must make — and continue to evaluate over time— essentially what % of your investments do you hold in each of equities and fixed income. All else equal more stocks means higher expected returns, but also higher volatility. There’s no universal right answer, but having an asset allocation that fits your plan and that you can stick to in poor markets is critical.
Individual investors they can achieve all five of these hallmarks by holding a single asset-allocation exchange traded fund (ETF) across all of their registered and non-registered accounts.
I won’t list the names of individual securities here but two of the largest providers are Vanguard and Blackrock and they offer “Conservative”, “Balanced”, “Growth”, and “All Equity” exchange traded funds that can give you all of the hallmarks above for <0.25% for self-directed investors. There’s a helpful comparison of the funds here: https://www.looniedoctor.ca/best-asset-allocation-etf/. If you aren’t comfortable making your own trades most robo-advisors implement a similar approach and cost ~0.5%.
There’s even a rapidly growing trend of investment advisors and financial planners putting their clients in asset allocation funds so they can focus more on financial planning instead of trying to beat the market.
For some very experienced individual investors with large portfolios ($500K+) asset location strategies (considering the after-tax impact of holding different securities in different accounts) and/or directly holding the underlying funds of an asset allocation fund might yield better after-tax performance. The big might here is that behavioral biases and/or rebalancing issues could easily offset the gains to be had, and there’s a significant time commitment involved.
PS the Rational Reminder podcast has been my go-to source for diving deep on evidence based investing: https://rationalreminder.ca/, they frequently host leading academics and world class investors. If you are just getting started learning about investments this episode is a great place to start: https://rationalreminder.ca/podcast/381
Have questions or want to talk about what this means for your personal situation? Book a free consultation or send me a note at chaz@gybefinancial.ca.