Once you’ve decided to begin investing in the stock market, you need to be wary of people telling you that they’ve got a “proven way to ‘beat the market.'” Listening to that type of stuff can be damning for a variety of reasons, least of which being that unless they’ve got a fairly reliable crystal ball, there are no proven strategies for beating the market going forward. They can say their strategy has beaten the market in the past but anyone with yesterday’s financial pages can say that. Many in the market subscribe to the efficient market hypothesis. Before you go sending off your retirement check to someone with a proven market-beating method, you should hear a bit about the efficient market hypothesis.
Some would call this theory the realist’s version of events. From Investopedia, the efficient market hypothesis is “an investment theory that states it is impossible to ‘beat the market.'” Okay, that’s fine to say but what does that mean? According to the hypothesis, “…because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information,” no one can ‘beat the market.’
That looks like it should sound right, but what does that mean? Broken down further, efficient market hypothesis offers that “…stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing.” So if this theory holds true then “…the only way an investor can possibly obtain higher returns is by purchasing riskier investments.”
Such a simple rule, everyone must agree on that right? Like all the most essential and simple truths, the real story is far more complicated. According to Investopedia, “although it is a cornerstone of modern financial theory, the efficient market hypothesis is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis.”
As in all theories though, there is another side to the story. Take, as an example, one of the world’s richest men, billionaire investor Warren Buffet. As reported back from Investopedia, Buffett’s “…consistently beaten the market over long periods of time, which by definition is impossible according to the EMH.” Another point of contention of the validity of this theory are events such as “the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day.” This clearly points to evidence to the contrary and that “stock prices can seriously deviate from their fair values.”
Whatever your belief on the efficient market hypothesis there is one thing that’s clear. As sure as the sun rises in the east, so is there some shyster trying to scam you out of your hard earned money. Whether you believe in theories such as the efficient market hypothesis or you don’t, the one clear, self-evident truth is that you need to be the captain of your own ship and you and you alone need to make your decisions with your money.