Evidence Based Investing

I have been searching for the ultimate, best solution in investments for my own benefit for the last 15 years.I had to realise that I am not the only one in this world (what a surprise!) and academics have been dealing with this topic for a very long time and some of them have become Nobel Prize winner for their research work. Here I merely undertake to present the practical best solutions in my opinion in order to bridge the gap between the big world and the interested Hungarian investors like you.

The investment industry has done very little to bring solutions to Hungary to serve your best interests in spite of the fact that such solutions have been existing for a couple of decades. As the saying goes we have been left out from this similarly to many other good things.

The investor, investment and markets

In order to enable you to understand the content of this webpage it is necessary to clarify a couple of basic things, terms, of course, just scratching the surface.

How can you get financial capital?

A company needs time to reach mature phase.

You also need time to build your private wealth, therefore I will only deal with long term investments spanning over 15 years, but better 20.This would imply that I can only talk to younger generation having enough time to build wealth with the means of compounding, and the achievements of academics in the field of economics.However, this could also be equally interesting to older generations as existing wealth must be also invested according to strict professional rules and I believe these people would also like to take care of their children and grandchildren.

Savings is the cash on a bank or any other liquid account that is meant to cover one-two years costs depending on the given person and/or family individual circumstances.

Any sum above these savings should be invested because inflation amounting on the long run to about 3 % per annum will eat it up.This is one of the biggest risks we bear without knowing or wanting it and we still do not or do not properly invest.

An investor is not a speculant therefore ‘investing’ via individual stocks or bonds is not viable. Let us leave this method to those seeking thrill or ways of quick enrichment. This is what we call gambling, or losing money on stock exchange.

A real investor never speculates around price changes, invests only in assets having return such as stocks, fixed income(bonds) and real estate funds.This webpage, however deals only with stock and bond funds.

I call institutions dealing with making these assets available for trade markets.

Assets Having Return

Dividend is the return of a stock, interest is the return of a bond. A commercial property earns a rent. No other assets have return, neither gold, oil, precius metals,art and other collections, therefore I will not deal with them.

Of course the price of such assets can change but that’s all, they have no return.

Investment funds can be basically classified according to their investment targets: stock, bond, balanced or money market funds.

Stock funds can be further categorised based on the companies market capitalisation as follows: Large, mid and small cap and each category can also be split into growth, value and mixed according of their composition.As we shall see later on other approach also does exist.

Bond funds are basically categorised on two factors: term and credit.

Of course, there is a myriad other way to categorise funds but for a start it is enough for us.

The key word for us is the amount of risk.

Funds are managed in active, passive or alternetive ways

In the UK this is about 10 %, in Hungary an index fund is just rather a curiosity, the penetration is not even measured by anybody.

An active manager picks individual stocks based on his or her own or a third party research trusting their good abilities to see future developments, predicting the future.

An active manager always wants to beat the market, and as we shall see they have difficulties in delivering. The overwhelming part of the market works on such basis with many well paid people, intermediaries earning sometimes astronomical bonuses.The Hungarian investment market virtually works on active basis.

A passive manager tries to as closely follow a market or a market part index as possible by buying securities composing the index and matching the structure of their own portfolio with that of the index on regular basis. Indeces are not available for direct investment.This passive method is a following approach and the aim is always to get as close to the performance of the index as possible.

The third, alternative method is called evidence based or factor investing which eliminates the drawbacks of the previous two approaches to investment on scientific basis.

And here is a rather shocking quote by a great scientist in economics, which paradoxically shows how interesting this topic will be.

Thus, after such a quick overview let us dig deeper and dive into scientific evidences: