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Evidence-based investing is a sound approach to investing that entails leaving no stone unturned.
Why Evidence-Based Investing is King: 5 Things You Should Know
Evidence-based investing is one of the most in-depth ways to fact find investment opportunities.
Finding the right investments is tough in a market full of automated bots, questionable news sources and general noise.
These factors can alter our emotions with investing, which makes evidence-based investing more important.
It can remove the entire emotional component of making investment decisions. There are plenty of tools that can unlock a successful investing strategy. These tools are available to retail investors. You, too, can find success investing in the stock market.
First off, let’s get into what this all means before going into how we can deploy it from an investment perspective.
What is Evidence-Based Investing?
Evidence-based investing is a fact-finding process. It’s a theory that through evidence you can uncover the most attractive risk-adjusted investment opportunities. Ritholtz Wealth Management is the absolute king of this method.
I’ve always considered fundamental analysis a key cog for any investor. If you aren’t conducting fundamental analysis, you are simply investing blind. Evidence investing takes this even one step further. It’s about making decisions based on facts rather than emotions.
I like using different financial ratios to make an investment decision, but that’s not the only thing to consider. There’s much more beyond that.
Think of yourself as Sherlock Holmes. You have a number of pieces to a puzzle and clues. You need to find the right answer. Once.
You only have one chance to find the right answer and make a claim.
Factors that Influence Investing
There are a million factors that will influence an investment on any given timeframe. Here are some core factors and we will evaluate them in the context of an evidence approach.
- Macroeconomic Influences
- Valuation Factors
- Underlying Financial Issues
- Capital Structure Issues
There are hundreds of other factors that influence our investment decision process. However, one thing that is certain, the above five important investing influences nearly all five can be controlled by a thorough evidence-based and fact-finding approach to investing.
If not all five, you can certainly uncover the core four. We may not be able to control macroeconomic factors, but anything company specific should be uncovered during your research.
Steps to Evidence Investing
Evidence investing is a long, thorough process that requires many steps. Also, there is no one-size-fits-all approach to this method of investing. You could be invested in various parts of the capital structure, so your approach can vary depending on if you are a debt or equity investor.
I’ll cover some of the most important ones that will help you develop your strategy and approach.
Every investor (and their goals) are different, so try to think about these steps and how they align with your end goal.
1. Use a Stock Screener
Use a stock screener to widdle down unnecessary stocks that don’t meet your specific criterion for investing. Believe it or not, the stock market is full of stocks that no one should be investing in.
I like using Finbox. This is the only tool that has everything that I need to use. I love the capabilities for excel plugins, the ability to follow gurus, comprehensive stock screeners, and so much more.
Best part you can try out their platform for $1 to start for premium by using my link. There are plenty of other stock screeners you can use. However, you must use a stock screener to identify stocks that are actually worth spending time on.
My criteria for finding undervalued stocks might be different from yours. Tune your criteria to find the right stocks for your risk tolerance.
2. Look Beyond the Numbers
In order to maximize compound interest, you need to buy at attractive valuations to ensure optimal total return over the long haul. A stock might check out on every valuation metric possible, but that won’t tell you the entire picture of a company. There could be some serious customer, safety and general quality issues with the company.
Take what you know about the numbers and do quality checks by using the internet to search for reviews, forum discussions about products and more. Go out and test the products for yourself.
3. Ask for Answers
What if the best data point about a stock is not from an investor themselves? That can actually be true. You can collect industry data by conducting a survey of individuals closest to the products or services directly.
Also, consider asking experts on their opinion. Think of yourself as an inspector with your investing strategy. You want all data points to collect your evidence to make the best decision possible.
You won’t know if you don’t ask. Ask questions. Each public company has an investor relations contact form, you can use this to email them a set of questions to get smarter about a particular company.
4. Question the Data
So you’ve done a lot of research and have your qualitative/quantitative ducks in a row. Is all the information right?
Take a step back from the data and evaluate whether or not your conclusions are actually correct. Every single piece of data that we see in research has flaws.
Make sure you know the flaws of your own data before proceeding.
You won’t be able to find alpha without it. Here are some ways to question your data and findings:
- Sensitize and stress test the information (if possible)
- Change the data to include findings from your other research
Also, play devil’s advocate with your information. At the same time, you don’t want to lose sight of proper thinking. It’s a bit of a balancing act.
5. Apply Your Findings to Real Life
Alright, so you’ve gone through the steps of finding as much as data as possible. You’ve questioned your findings… Start out by level setting your expectations for profit by using a calculator to factor in fees and other costs associated with the transaction.
What’s worse than being wrong? Not trying at all. The only way to find out if your methods worked properly is to deploy your findings. Learn from your mistakes.
Retrace your steps and tune your strategy. Once you get in a rhythm, you’ll find that investing can be pretty easy.
If you find that a stock has a major red flag, then delete it from your strategy and move on. There are a million ways to make money in the stock market.
Build a portfolio using a free platform like M1 Finance. It’s completely free and allows you to build creative portfolios of stocks. I’ve used it to create M1 Finance Pies, which include a basket of stocks that meet my diligence and financial ratio criteria.
You can view some of my examples of M1 Finance Pies to spark your creativity.
Evidence Investing Firms and Resources
What to become an expert at evidence-based investing? Here are some amazing resources to help expand your knowledge and become a better investor. Who are the best evidence investors?
- Ritholtz Wealth Management: There are some awesome resources on evidence oriented investing on their website. Their team is some of the smartest people on Wall Street. Within their team, there’s some of the best investing professional relating to fundamental analysis, technical analysis, investing, trading, etc.
- The Intelligent Investor: The Intelligent Investor is a book by the value investing legend himself, Benjamin Graham. The Intelligent Investor is considered the definitive book on value investing. Graham’s philosophy of “value investing” — which shields investors from substantial error and teaches them to develop long-term strategies — has made The Intelligent Investor the stock market bible ever since its original publication in 1949. He doesn’t implicitly call out evidence-oriented investing, but at its core, value investing involves uncovering all possibilities to understand the true intrinsic value of a stock.
You should surround yourself with people that think the same way as you in regards to the entire fact-finding process associated with investing.
5 Things You Should Know About Evidence-Based Investing
There are plenty of things to know about an evidence-based investing strategy before you get started. Below are some general tips about this method of investing your money.
1. Ignore the News
One of my favorite parts about using evidence to build your case for (and against) a stock, is that you get to tune out mainstream media, opinions and talking heads. There’s a fine line here.
You need to continually read and find facts. So, don’t stop your learning curve along the way.
The goal with this component to the investing diligence process is to ignore opinions. Do you think an investigator or Sherlock Holmes cared about what the public opinion thought? No, they shelter themselves from the public opinion to make factual decisions.
2. Successful Evidence-Based Investing Doesn’t Happen Overnight
Try and try again. Even experts spend a lifetime continually honing their craft. If you want to conduct proper fact-finding due diligence, you need to deploy your findings and track the results.
By tracking your success and documenting every step of the way, you inherently become a better investor over time. This won’t happen in the matter of a day or two. Nor will it happen in months. It might take years.
Stay patient and you will get better over time. You’ll be amazed at the results.
3. You Will Be Wrong
Mistakes are going to happen. This is an opportunity to redeem yourself and get smarter. Don’t kick yourself when you are down. Get better from your mistakes.
I remember my first investment. It was an investment in consumer products stock. I thought I had every box checked. I was on my way to becoming the next Benjamin Graham.
Boy, I was wrong. I completely missed so many aspects of the business. If you are going to quit from being wrong once, this is not a sound way to invest for you.
4. Find a Mentor
Like the many resources that I provided above, there’s actually a lot of helpful people that participate in the stock market. Find someone that will help you develop your strategy and provide feedback.
Your mentor will have so many insights about the things they’ve learned about investing. This information is invaluable because it includes information that you will likely already find along the way.
It’s a great way to be granted into a periscope into the future… You might end up avoiding a mistake or two along the way.
5. We Live in the Information Age, Get Creative
One thing that has continually favored evidence investing is the fact that we have a lot of information at the dispose of our fingertips. Not only can you get information at the push of a button, but you can also find help to find the right information at the push of a button.
Get creative with your investing goals even if it means that it will cost you a few hundred dollars up front to have someone help you obtain your evidence.
These are some helpful ways you can work smarter, not harder:
- Hire a freelance stock research analyst to compile data
- Use publicly available resources from governmental agencies to compile data
- Create a survey for people in the product or service offering’s demographic
- Conduct outreach to professional investors to get feedback on a potential investment opportunity and your findings
Conclusion on Evidence-Oriented Investing
If you conduct proper research and tune your strategy over time, you shouldn’t revisit your old investments down the road and say I thought I saw that coming! In fact, with every new investment, you should have level-set expectations about the present and the future.
There are a lot of things we can’t control in the stock market, but one thing that’s for certain is there is a lot of information at our disposable to become better investors. Every day. Avoid the many myths associated with investing and start putting your money to work.
The important part of this way of investing and due diligence is to craft it to your personal style as much as possible.
What is your favorite thing about evidence-based investing? Let us know in the comments below. We’d love to hear from you.
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