Evidence Wealth: Investing Made Simple, Logical, and Worry-free

By James N. Whiddon and Matthew L Gentry

Everyone knows that human beings can't predict the future. Yet, Wall Street and its minions maintain otherwise with their "latest and greatest secrets," which result in confusion, hit-or-miss approaches, and exaggerated return claims. This can be very frustrating for any investor. We'll take you "behind the curtain" to expose the tricks of the investing trade so you won't fall victim. Then the good news . . . Evidence Wealth changes everything. We'll show how, as a free-market participant, you can have a successful investing experience through Evidence-Based Investing (EBI). This approach uses a Nobel Prize-winning, data-driven methodology to create the optimal investing framework. Then once this financial piece is in order, you can focus more on those things that bring true wealth into your life: investing wisely of your time, talents, and relationships. Congratulations! The next few hours are going to make a significant impact in your life as you discover the only investment strategy you will ever need.

• Language: English
• Publisher: Open Road Integrated Media
• Release date: Oct 26, 2023
• ISBN: 9781612546568

Book preview

Introduction

"There seems to be an irrational human characteristic

that likes to make easy things difficult."¹

—Warren Buffett

In more than a half century of combined experience in the financial services industry, we have interviewed thousands of investors who’ve told us of their frustration with the constant barrage of confusing and conflicting investment information, hit-and-miss approaches, and exaggerated return claims. We must humbly admit that early in our careers, we, too, were caught up in the conventional-investing advice system with its black box secrets.

But our professional lives changed forever when we discovered Evidence-Based Investing (EBI)—an investing approach that analyzes factual and time-tested historical data and applies it in a systematic manner. That meant no more dependence on those who claim stock-picking clairvoyance and crystal ball market-timing prowess to try and outguess all other market participants. Now we spend our working hours providing the proofs that define the obvious objective choices for investors to make. Simply put, our mission is to rescue as many investors from the Wall Street minions and mainstream media as will listen. That’s why we wrote this book.

When an investor walks into our conference room to ask us for a review of their current investment portfolio, we typically see at least one of these three common mistakes:

They are taking unnecessary risks. The most common example of this occurs when there is an overconcentration of certain investments in a portfolio—or a lack of proper diversification.

They are missing out on the key optimizers of market return. Many investors are simply unaware of where investment returns come from—or that they are basically there for the taking in the long run. Instead, they blindly follow the Wall Street wizards.

They are losing money to unforced errors. This often shows up in easy-to-fix mistakes: paying higher-than-needed taxes or just having the wrong investment in the wrong type of account. Other mistakes are much worse: making The Big Blunder of panic selling out of the market. The refrain, short-term thinking is the enemy of long-term success, is never more evident than in the investing realm.

Now, consider that if even one of these three areas in your portfolio is out of line, then your entire nest egg is exposed and vulnerable. Sadly, and most often, we see all three mistakes being committed.

What about you?

On a scale of 1 to 10, with 10 being the highest, how confident are you that you’ve avoided these mistakes?

If you gave yourself a perfect score, then you may be wasting your time. Then again, you may want to stay around and make sure there are no surprises. If you don’t currently score yourself in the top tier, we fully expect your number to be higher after reading this book.

In light of this, we must warn you that some of the information presented in this book may be unsettling. You’ll need to unlearn some concepts you likely thought were set in stone. We’re going to take you behind the curtain to expose some of the tricks Wall Street uses—and you won’t be pleased after you see them.

Beyond this bad news comes great news: investing in free markets means that everyone can be a winner. Yes, that means you and every investor can have a piece of an ever-expanding economy. The returns of the market are essentially there for the taking and, as Mr. Buffett implies, it’s far less complicated than you might think.

Evidence Wealth is divided into nine chapters:

Chapter 1 is an important examination of how markets really work. Herein, you’ll find several surprises to traditional thinking that you may have believed yourself over the years. We let the data speak for itself to instill great confidence in the free markets in which we are all blessed to be participants.

Chapters 2 and 3 critically examine Wall Street’s popular methods of trying to outguess the market by timing the market ups and downs or picking stocks, which, as you will see, amounts to no more than buying lottery tickets. Chapter 4 builds on this evidence to show how these common short-term strategies lead to the insidious desire to chase performance, thereby causing investors to chase their own proverbial investment tails. This section of the book makes it abundantly clear how active portfolio management is a loser’s game.

In the second half of the book, we introduce the Evidence-Based Investing methodology in detail. Chapter 5 discusses the critical topic of superdiversification and the building blocks of EBI-portfolio construction. Chapter 6 shows how to capture the optimizers of market returns that nearly every investor misses.

In Chapter 7, we take a short journey inside our heads to be introspective concerning our attitudes about money and how to best handle the emotions that come with it. In Chapter 8, we then discuss the three disciplines needed to succeed in your investment plan over the long term. We also instruct you concerning the important task of choosing the right coach. Herein, we provide the must haves in any client and advisor relationship, plus the exact questions to ask when you interview advisor candidates.

Chapter 9 brings with it a discussion about true wealth, which involves much more than money. As advisors and authors, the content in this book concerns the most rewarding and important aspect of what we do.

Finally, we added a Postscript that deals with faith-driven investing for those who have an interest in aligning their faith with their finances. Devoted and enterprising financial professionals have done yeoman’s work in this arena, and we look forward to sharing the topic with those who might be interested.

And now, without further delay, we are proud to present the only investment strategy you will ever need. We are confident it will lead you to a worry-free investing experience and enable you to focus on the things that really matter.

James N. Whiddon and Matthew L. Gentry

CHAPTER 1

Understand How

Markets Work

Markets go up and markets go down.¹

—Ronald Reagan, October 19, 1987 (Black Monday)

We believe that everyone can have a worry-free investing experience. That’s because free markets are efficient, resilient, and prosperous for all.

When you fully understand these truths, it will transform the way you think about investing and eliminate needless concerns.

Let’s start with our fortieth president’s favorite snack.

FREE MARKETS ARE EFFICIENT: The Jellybean Experiment

At an event we hosted several years ago, a large jar was placed in the lobby, and guests were asked to estimate the number of jellybeans it held before they entered. The participants wrote down their estimates, and whoever came closest to the actual count received a prize.

There were thirty-five estimates put forth, and they had a wide variance—from 308 to 4,315 jellybeans. The average of all estimates was 1,759. The actual count was 1,776. Incredibly, the average had come within just under 1 percent of the exact number.

This experiment has been repeated many times with the average of all guesses usually falling within 5 percent of the actual count. How is this possible? Crowdsourcing. Simply defined, it’s obtaining information or input from a sufficiently large number of people. And while only a few dozen people can have an impressive predictive record for President Reagan’s favorite candy in a jar, what might the results be if we had millions of participants estimating the prices of public companies in the stock market? The answer is a highly efficient market.

Securities Are Efficiently Priced

The market is an efficient information-processing and pricing machine. Every day, millions of market participants all over the world come together and process nearly a trillion dollars in trades. Most of these trades are made by professional money managers, analysts, and traders who spend the bulk of their day doing one thing: consuming all the available information they can find on the stocks they’re looking to buy or sell.

Each participant brings their interpretation of that information to the market, and a transaction takes place. The resulting price between a willing buyer and a willing seller can then be viewed as the most accurate estimate of current value based on real-time information. In other words, it reflects the collective knowledge of all investors in a particular stock. When new information becomes available, market participants are then forced to reevaluate their estimates and negotiate a new fair price.

As long as capital markets remain free to operate in this manner, it will continue to provide the most accurate price estimates through the most efficient means possible. Therefore, investors can generally accept the market price as the best estimate of actual value at any given time. Herein lies the cornerstone of worry-free investing. By embracing market efficiency, you put its vast shared knowledge to work for you in your portfolio.

Just as we saw with the jellybeans, we know more together than we do alone. You no longer need to worry about whether you’re missing some critical piece of information because everything that is known about a stock is reflected in the current price. Investors who reject this premise are pitting themselves against the combined knowledge of all market participants and entering the realm of subjectivity (as shown in Figure 1.1). Good luck. They will need it!

Markets Regress to the Mean

While counting jellybeans is a fun and tangible way of explaining why markets are so efficient, it also speaks to an important investing concept known as regression to the mean. In the context of the stock market, the idea of regression conveys that stock prices are affected by many factors over time. These market factors eventually work together to adjust extreme stock price valuations back to a mean—or average level.

In the jellybean exercise, the low valuation of 308 and the high valuation of 4,315 were obviously way off. As more estimates of value came in, the mean eventually prevailed at 1,759. The same is true of the market. As millions of pieces of information stream in, investors make decisions (buy, hold, or sell) that collectively combine to set market prices. This is why we will often say, The market is always right—eventually. And with the scope of technology and rapid communication of the Information Age, prices adjust instantly.

Another characteristic that should bolster confidence in market efficiency comes with understanding how regression to the mean also buffers against extreme market events. Whether it be economic distress, political upheaval, war, or another pandemic, investor fear can be mitigated by understanding that large, sudden departures from the mean caused by such events are unrepresentative of how markets typically act. Therefore, a market drop is accompanied at some point later by a return to the mean. Isn’t this exactly what we saw in 2020 after the COVID-19 onset? (Figure 1.2)²

When President Trump went on national television on March 11 announcing a ban on all travel from Europe, it was a jaw-dropping moment. By March 16, the Dow Jones Industrial Average set another record, losing 2,997.10 points to close at 20,188.52.³ That day’s percentage plummet exceeded the infamous October 1929 Black Monday slide that started the Great Depression. Yet, just eight months later around Thanksgiving, the Dow was surging past 30,000 points. The Standard & Poor’s 500 Index® (S&P 500) ended 2020 with an 18.4 percent gain. The Russell 3000 Index®, representing small US stocks,