An Evidence-based guide to investing

What’s the point of investing, anyway? We invest our money for future consumption, with the idea that we’ll earn a higher rate of return from investing in a portfolio of stocks and bonds than we will from holding cash.

But where does this equity premium come from? And how do we capture it without taking on more risk than is needed? Moreover, how do we control our natural instincts of fear, greed, and regret so that we can stay invested long enough to achieve our expected rate of return?

For decades, regular investors have put their trust in the expertise of stockbrokers and advisors to build a portfolio of stocks and bonds. In the 1990s, mutual funds became the investment vehicle of choice to build a portfolio. Both of these approaches were expensive and relied on active management to select investments and time the market.

At the same time, a growing body of evidence suggested that stock markets were largely efficient, with all of the known information for stocks already reflected in their prices. Since markets collect the knowledge of all investors around the world, it’s difficult for any one investor to have an advantage over the rest.

The evidence also showed how risk and return are intertwined. In most cases, the greater the risk, the higher the reward (over the long-term). This is the essence of the equity-risk premium – the excess return earned from investing in stocks over a “risk-free” rate (treasury bills).

Evidence-based investing also highlights the benefit of diversification. Since it’s nearly impossible to predict which asset class will outperform in the short-term, investors should diversify across all asset classes and regions to reduce risk and increase long-term returns.

As low-cost investing alternatives emerged, such as exchange-traded funds (ETFs) that passively track the market, the evidence shows that fees play a significant role in determining future outcomes. Further evidence shows that fees are the best predictor of future returns, with the lowest fees leading to the highest returns over the long term.

Finally, it’s impossible to correctly and consistently predict the short-term ups and downs of the market. Stock markets can be volatile in the short term but have a long history of increasing in value over time. The evidence shows staying invested, even during market downturns, leads to the best long-term investment outcomes.

Evidence-based Guide to Investing

So, what factors impact successful investing outcomes? This evidence based investing guide will reinforce the concepts discussed above, while addressing the real-life burning questions that investors face throughout their investing journey.

Questions like, should you passively accept market returns or take a more active role with your investments, should you invest a lump sum immediately or dollar cost average over time, should you invest when markets are at all-time highs, should you use leverage to invest, and how much home country bias is enough?

To answer these questions, I looked at the latest research on investing and what variables or factors can impact successful outcomes. Here’s what I found:

Passive vs. Active Investing

The thought of investing often evokes images of the world’s greatest investors, such as Warren Buffett, Benjamin Graham, Peter Lynch, and Ray Dalio: skilled money managers who used their expertise to beat the stock market and make themselves and their clients extraordinarily wealthy.

But one man who arguably did more for regular investors than anyone else is the late Jack Bogle, who founded the Vanguard Group. He pioneered the first index fund, and championed low-cost passive investing decades before it became mainstream.

Jack Bogle’s investing philosophy was to capture market returns by investing in low-cost, broadly diversified, passively-managed index funds.

“Passive investing” is based on the efficient market hypothesis: that share prices reflect all known information. Stocks always trade at their fair market value, making it difficult for any one investor to gain an edge over the collective market.

Passive investors accept this theory and attempt to capture the returns of all stocks by owning them “passively” through an index-tracking mutual fund or ETF. This approach avoids trying to pick winning stocks, and instead owns the market as a whole in order to collect the equity risk premium.

The equity risk premium explains how investors are rewarded for taking on higher risk. More specifically, it’s the difference between the expected returns earned by investors when they invest in the stock market over an investment with zero risk, like government bonds.

Bogle’s first index fund – the Vanguard 500 – was founded in 1976. At the time, Bogle was almost laughed out of business, but nearly 50 years later, Vanguard is one of the largest and most respected investment firms in the world. Who’s laughing now?

In contrast, opponents of the efficient market hypothesis believe it is possible to beat the market and that share prices are not always representative of their fair market value. Active investors believe they can exploit these price anomalies, which can be observed when trends or momentum send certain stocks well above or below their fundamental value. Think of the tech bubble in the late 1990s when obscure internet stocks soared in value, or the 2008 great financial crisis when bank stocks got obliterated.

Comparing passive vs. active investing

Spoiler alert: there is considerable academic and empirical evidence spanning 70 years to support the theory that passive investing outperforms active investing.

The origins of passive investing dates back to the 1950s when economist Harry Markowitz developed Modern Portfolio Theory. Markowitz argued that it’s possible for investors to design a portfolio that maximizes returns by taking an optimal amount of risk. By holding many securities and asset classes, investors could diversify away any risk associated with individual securities. Modern Portfolio Theory first introduced the concept of risk-adjusted returns.

In the 1960s, Eugene Fama developed the Efficient Market Hypothesis, which argued that investors cannot beat the market over the long run because stock prices reflect all available information, and no one has a competitive information advantage. Continue Reading…

Is a Tax Credit a better way to support Social Housing?

image courtesy CMI Financial Group

By Kevin Fettig

Special to Financial Independence Hub

One of the biggest challenges in Canada’s rental housing crisis is the lack of new affordable housing units being built.

Despite efforts through the National Housing Strategy’s five programs, only 17,000 units were delivered after four years. This disappointing outcome is only a modest improvement over Ottawa’s track record in the past 30 years. For example, between 1996 and 2013, fewer than 7,000 new units were provided by federal and provincial governments.

In contrast, the United States built 3.5 million subsidized rental units from 1987 to 2021. Adjusted for population, this is equivalent to building 11,000 units per year in Canada. Both countries have tightened the tax benefits of rental real estate, but the U.S. offset this policy shift by introducing the Low-Income Housing Tax Credit (LIHTC) to mitigate the impact of these changes on low- and middle-income renters.

A Canadian LIHTC would offer an alternative method of federal funding by leveraging private-sector expertise in owning, building, and managing low-income rental housing. The LIHTC would provide tax credits to both for-profit and nonprofit owners of rental housing, with nonprofits having the option to sell these tax credits. A key aspect of the program would be its efficient resource allocation, achieved by creating competition among developers for tax credits and using a market-based test for the viability and need for low-income housing.

Complements existing Renter Support Initiatives

The program could be designed to complement existing renter support initiatives, such as local government programs, housing allowances, and rent supplements. It would work by providing tax credits to developers, who would then pass them on to investors to offset their income tax.

Unlike earlier tax credit programs like the Multiple Unit Residential Buildings (MURB) provision, this program would have a cap, with credits allocated annually to each region based on population. The credits would be federally funded and awarded according to provincial objectives. Continue Reading…

Beat the TSX portfolio, Canadian Wide Moats rule

By Dale Roberts, cutthecrapinvesting

Special to Financial Independence Hub

In this Sunday Reads we’ll begin with a look at the first half returns for the Beat The TSX Portfolio and the Canadian Wide Moat Portfolios. The Beat The TSX Portfolio is a pure value play, discovered by those big dividends. The Canadian Wide Moat Portfolio relies on the moats – a lack of competition. There are a few key oligopoly sectors in Canada. While both Canadian stock portfolio approaches have a nice history of beating the market, the BTSX is more volatile, while the Wide Moats are more low volatility by design. The BTSX Portfolio continues to struggle while the Wide Moats continue to best the market.

Here’s the updated post on The Beat The TSX Portfolio.

For the first half of 2024, it’s 6% vs 1.3% in favour of the passive TSX Composite.

And here’s the updated post for the Canadian Wide Moat Portfolios.

The wide moat portfolio has beat the TSX by some 1.6% annual over the last decade. That said, it has underperformed from 2023. I can still find no better model for the large cap Canadian space. It tracks closely to (but slightly outperforms) the BMO Low Volatility ETF – ZLB.TO.

Shareholder yield

I really liked this post and screen in the Globe & Mail (sub required). Companies that have a lot of free cash flow typically perform very well. They can buy back shares (increasing your ownership) and pay bigger and increasing dividends. We call that combination the shareholder yield. The screen also looked at valuation, quality and more. Here’s where it landed. It’s a nice sixpack …

And check out the buy back and dividend history for Canadian Natural Resources. My favourite oil and gas stock …

More on oil and gas …

The markets last week Continue Reading…

Navigating the Challenges of Solo Entrepreneurship


By Devin Partida

Special to Financial Independence Hub

Solo entrepreneurs face unique financial challenges, including inconsistent income streams, high operational costs, limited access to capital and the difficulty of separating personal and business finances. Effective financial planning becomes crucial to navigating these hurdles and ensuring sustainable business operations and long-term success.

Creating realistic budgets, building emergency funds and managing expenses allows solo entrepreneurs to stabilize their financial health. Additionally, seeking professional financial advice offers personalized strategies, tax planning and investment guidance, which are essential for securing a stable and prosperous future.

Unique financial hurdles for Solo Entrepreneurs

Variable revenue presents significant challenges for solo entrepreneurs in budgeting and managing expenses. The unpredictable nature of income makes it difficult to plan for consistent cash flow, often leading to financial strain. According to a recent survey, 77% of respondents reported their expenses increased by 6% or more due to inflation, further complicating financial planning.

Solo entrepreneurs also face the challenge of managing overhead costs without the benefit of economies of scale. Unlike larger businesses that can reduce per-unit costs through bulk purchasing, they must find ways to cover operational expenses efficiently. In fact, 37% of small businesses resort to borrowing to meet their operating expenses, which highlights the financial pressure they endure.

Securing loans and investments is another hurdle for solo entrepreneurs. Financial institutions and investors may view them as high-risk due to their lack of a proven track record and limited collateral. This makes it difficult for single proprietors to obtain the necessary funding to grow and sustain their businesses. Continue Reading…

Are Alternative Investments really the Holy Grail of Investing?

By Michael J. Wiener

Special to Financial Independence Hub 

Tony Robbins’ latest book, The Holy Grail of Investing, written with Christopher Zook, is a strong sales pitch for investors to move into alternative investments such as private equity, private credit, and venture capital.

I decided to give it a chance to challenge my current plans to stay out of alternative investments.  The book has some interesting parts — mainly the interviews with several alternative investment managers — but it didn’t change my mind.

The book begins with the usual disclaimers about not being intended “to serve as the basis for any financial decision” and not being a substitute for expert legal and accounting advice.  However, it also has a disclosure:

“Tony Robbins is a minority passive shareholder of CAZ Investments, an SEC registered investment advisor (RIA).  Mr. Robbins does not have an active role in the company.  However, as shareholder, Mr. Robbins and Mr. Zook have a financial incentive to promote and direct business to CAZ Investments.”

This disclosure could certainly make a reader suspect the authors’ motives for their breathless promotion of the benefits of alternative investments and their reverence for alternative investment managers.  However, I chose to ignore this and evaluate the book’s contents for myself.

The most compelling part of the pitch was that “private equity produced average annual returns of 14.28 percent over the thirty-six-year period ending in 2022.  The S&P 500 produced 9.24 percent.”  Unfortunately, the way private equity returns are calculated is misleading, as I explained in an earlier post.  The actual returns investors get is lower than these advertised returns.

Ray Dalio and uncorrelated investment strategies

The authors frequently repeat that Ray “Dalio’s approach is to utilize eight to twelve uncorrelated investment strategies.”  However, if the reported returns of alternative investments are fantasies, then their correlation values are fantasies as well.  I have no confidence as an investor that my true risk level would be as low as it appears.

Much of the rest of the authors’ descriptions of alternative investments sounds good, but there is no good reason for me to believe that I would get better returns than if I continue to own public equities.

I choose not to invest in individual stocks because I know that I’d be competing against brilliant investors working full-time.  I don’t place my money with star fund managers because I can’t predict which few managers will outperform by enough to cover their fees.  These problems look even worse to me in the alternative investment space.  I don’t lack confidence, but I try to be realistic about going up against the best in the world. Continue Reading…