A friendly discussion about whether markets are efficient can easily turn into a heated debate. There are strong feelings on both sides.
What it all boils down to is whether an investor or money manager can use available information — including earnings reports, economic indicators, financial ratios, historical price patterns, technology claims, analyst ratings, political news, phases of the moon, or anything else — to find securities that are priced “too high” or “too low.” An investor who could systematically find these so-called inefficiencies would easily outperform the markets by buying the underpriced securities and selling them when other investors eventually see their true worth.
Inefficiencies are elusive
Systematically is the key word here. Surely there are cases when information and price do not match up. These inefficiencies are very easy to identify after the fact but difficult or impossible to systematically recognize and exploit in real time. If you pick enough stocks based on perceived inefficiencies, or try to time the market again and again, you will surely hit some home runs. But there’s little evidence that anyone can systematically do so in a way that beats the market consistently.
As I see it, you’re likely to pick lots of losers or get out of the market when it would have been more profitable to stay in. (See our article on efficiency at the supermarket.)
At Osbon Capital we don’t believe in chasing elusive or imaginary inefficiencies. We focus on the factors that can be controlled: diversification, asset allocation, rebalancing, expense control, and tax efficiency. It is our belief that disciplined, goal-driven asset management, not stock picking, is ultimately the best use of our time in working for our clients.
Keep gambling separate
All of this said, it is exquisitely human to get a hunch now and then. It’s fun to spot a stock that no one else loves and watch it make a heroic climb. It’s highly satisfying to take a flyer now and then, one that really soars. I would never try to talk anyone out of speculating on a stock now and then. But I’d advise keeping those speculative bets completely out of your “real” portfolio, the one that will fund college educations, weddings, and many years of retirement.
If you feel the need to act on what you see as market inefficiencies, do it with fun money, a small separate account you’re willing to lose and forget about if your sure thing turns out to be a big nothing. Enjoy the gambling, but don’t confuse it with investing.
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Each of my 25+ years in the investment industry has reinforced one key idea it's impossible to predict the future, but essential to prepare for it.
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