The Efficient Market

The Efficient Market

What is the Efficient Market Theory?

Evidence to support the Efficient Market Theory

Ways to beat market averages

Why people try to beat the market

What is the Efficient Market Theory?

Assumptions

• The market is full of intelligent investors
• Information useful for determining prices is available to everyone nearly simultaneously

Under these conditions it is very difficult to beat the market averages

Another way to look at it

Everyone thinks they can beat the market averages

But by definition, not everyone can beat the market averages

• Half do better
• Half do worse

Evidence to support the Efficient Market Theory

There are about 100,000 full-time investment professionals who follow perhaps 3,000 stocks

Since each follows about 30 stocks, there are 1,000 professionals following each stock

A fund that blindly invests in an index that matches the Standard & Poors 500 has outperformed about 75 percent of all actively managed stock mutual funds

The low fees charged by the index fund are a key factor in this superior performance

Ways to beat market averages

Dumb luck

Forbes dartboard portfolio roundly beats market averages and most professionals

By accepting more risk

Peter Lynch has a great record of beating the averages

But in the 1987 crash, when most stock funds lost 16 percent of their value, Lynch's Magellan fund lost 32 percent of its value

Why people try to beat the market

Because of compounding, beating the market by a little over time can dramatically increase your wealth

It's fun!