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Evidence-Based Investing: What Is It?

Some avid investors will say that there’s an art and a science to investing. But when it comes to choosing an investment style that works for you and your specific needs, you’ll likely come across terms such as passive investments, active investments, emotional investing and evidence-based investing without much knowledge of what they are or how they differ. As you’re deciding which types of investments you’re interested in pursuing, here's some helpful information to help you learn more about evidence-based investing and how it differs from other types of investment styles. FYI, this Active vs. Passive debate is the financial services equivalent of Left vs Right in today's political word... Oil and Water.

Actives Versus Passive Investing

To start, you’ll want to understand the difference between active and passive investments. It’s important to note that there are many different types of portfolio strategies that incorporate both active and passive investments. Some may, at times, recommend a mixture of both in an effort to help investors create an appropriate portfolio for their specific needs and tolerance for risk.  Other's are firmly on one side or the other.

Active Investing

As the name implies, active investing is more hands-on approach. With this type of investing, you or your money manager is looking at more short-term fluctuations in the prices of stocks and bonds to decide when the best time is to sell or buy. In many cases, active portfolios are looked after by an analyst or a team of analysts who use various factors to decide when and what to buy or sell.  The active management value proposition is that they can outperform their benchmark and/or better protect your money using their research, analysis, trading strategy, etc. 

Passive Investing

If we think of active investing as being a hands-on approach, consider passive investing more hands off. The most common example we see is an Index Fund.  These are one type of passive fund.  Taking a longer-term look at the market than its counterpart, passive investing strategies typically involve less buying and selling and more buying and holding. With passive investing, a certain amount of discipline is often needed to resist the urge to buy and sell based on current market conditions or economic climates. 

What Is Evidence-Based Investing?

With this approach to investing, investors make decisions about buying and selling based on what they know to be factually true, most often through academic research. Instead of basing decisions on current market trends or conditions, investors turn to research, education and historical data to guide their decision-making process.

Evidence-Based Versus Emotional Investing

Emotional investing is, as it sounds, investing with your emotions. As you hear unsavory news about a company’s CEO, your first reaction could be to quickly sell your stock before it tanks. But what happens if say, one month later, news breaks that the company’s new CEO has plans to double the company in size by the end of next year. Suddenly, their stock could be on the rise once more. Making your investment decisions based on your emotional or behavioral reaction to news, political changes or shifting economic climates is considered emotional investing.

Unlike emotional investing, the decision to buy or sell with evidence-based investing is not made based on current shifts in climate or news. Instead, it remains steadfast through trends and climate changes because it is based on predetermined factors and considerations.

Whether you choose to take a do-it-yourself approach to portfolio management or you select an investment advisor to help you along the way, you’ll want to consider which types of investing will work best for your portfolio and unique needs. Understanding the difference between popular investment terms including active, passive, behavioral and evidence-based is the first step to making informed decisions about your investment strategies.

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

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