A question market analysts often ask is whether the stock market is efficient and therefore too difficult for the individual investor to beat. According to the Efficient Market Hypothesis, we’re better off investing in broadly based index funds and exchange-traded funds rather than picking individual stocks.
Advances in computing speeds and the transmission of information have made the flow of data faster, providing more meat to the assertion that stock prices reflect all currently available information. Traders can react with lightning speed to events and announcements, while high-speed trading firms are battling to find minuscule advantages that over the long term can add up to major profits.
So in that way the market is more efficient. But in our view it’s a stretch to say that the market is too efficient for individual investors. Academic debate has been vigorous on this subject. On one side are researchers who point to market crashes, studies in behavioral finance and other evidence as proof that markets aren’t efficient. On the other side are those who believe that luck plays an important role in outperformance.
Warren Buffett eloquently refutes that luck accounts for outperformance. Buffett is a longtime skeptic of EMH, saying that it’s simply a construct of business schools without a real-world basis. In his 2006 letter to shareholders of Berkshire Hathaway, he recounts the experiences of his friend Walter Schloss, who maintained a simple office and never had inside information.
Yet Schloss was able to outperform the Standard & Poor’s 500 index dramatically over 47 years. “It’s safe to say that had millions of investment managers made trades by a) drawing stock names from a hat; b) purchasing these stocks in comparable amounts when Walter made a purchase; and then c) selling when Walter sold his pick, the luckiest of them would not have come close to equaling his record,” Buffett said. “There is simply no possibility that what Walter achieved over 47 years was due to chance.”
History offers some simple lessons for long-term success:
- Follow a consistent process that focuses on a company’s fundamental data — BetterInvesting’s methodology allows you to find quality stocks quickly
- Don’t try to time the market — invest regularly
- Have some measure of diversification in your portfolio
- Reinvest earnings and dividends to allow the miracle of compounding to work for you
You’ll likely not match Buffett’s and Schloss’s record. But if you follow a consistent, simple process for identifying high-quality stocks selling at reasonable prices and employ BetterInvesting’s principles, you should be well on your way to ensuring financial security.