This article was submitted by Jim Stark, a practicing financial advisor who wanted to share some food for thought. If you would like to submit an article to be published on AlphaAdvisor.ca please send your submissions to preetb@pro-financial.ca.

So I hopped on to my computer one morning and typed in the phrase “scientific method” into my search engine to see what came up. Here’s the definition that our friends at Wikipedia use:

Scientific method refers to the body of techniques for investigating phenomena, acquiring new knowledge, or correcting and integrating previous knowledge. It is based on gathering observable, empirical and measurable evidence subject to specific principles of reasoning.[1] A scientific method consists of the collection of data through observation and experimentation, and the formulation and testing of hypotheses.[2]

Although procedures vary from one field of inquiry to another, identifiable features distinguish scientific inquiry from other methodologies of knowledge. Scientific researchers propose hypotheses as explanations of phenomena, and design experimental studies to test these hypotheses. These steps must be repeatable in order to dependably predict any future results. Theories that encompass wider domains of inquiry may bind many hypotheses together in a coherent structure. This in turn may help form new hypotheses or place groups of hypotheses into context.

Among other facets shared by the various fields of inquiry is the conviction that the process be objective to reduce a biased interpretation of the results. Another basic expectation is to document, archive and share all data and methodology so they are available for careful scrutiny by other scientists, thereby allowing other researchers the opportunity to verify results by attempting to reproduce them. This practice, called full disclosure, also allows statistical measures of the reliability of these data to be established.

As far as I can tell, the preponderance of evidence supports the notion that the majority of active products and strategies fail to outperform and that the ones that do cannot be reliably identified in advance. It’s sort of like lottery tickets. The majority of tickets sold are losing tickets and the ones that are actually winners cannot be reliably identified until the winning numbers are called. The obvious rhetorical question that begs asking is: “Should advisors actively encourage their clients to buy lottery tickets?”

To be absolutely clear, everyone (advisors and investors alike) is entirely entitled to do what they personally feel is best. My concern is when people make decisions (and recommendations) without a reliable basis of factual evidence and fail to disclose that lack of reliable evidence. Is the question of appropriateness of approach one of fact or opinion? If it is a question of fact, there is considerable empirical evidence in support of passive products and strategies. If it is a question of opinion, then surely it ought to be disclaimed as such. What I find particularly telling is the notion of full disclosure. Irrespective of how you might personally feel about this conundrum, do you fairly disclose this fact/opinion and bring both alternatives to your clients?

-Jim Stark

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