It is possible to beat the market
This week, the Royal Swedish Academy of Sciences awarded the 2013 Nobel Prize to three deserving American economists: Eugene Fama, Lars Peter Hansen and Robert Shiller. Fama, of the University of Chicago, famously wrote the 1965 paper "Random Walks in Stock Market Prices," demonstrating that the stock market is highly efficient at rapidly pricing all publicly available information into stock prices. But it is possible to beat the market. Read on to find out why...
How does the stock market achieve this efficiency? Simple, Alexander Green in Investment U
Every day, investors, analysts and other curious people are out there talking with employees, suppliers, customers and competitors of publicly traded companies. The information they glean as rational, self-interested individuals filters into the stock market through their buying and selling decisions.
A sensible investment strategy
Burton Malkiel took this knowledge and turned it into a classic investment book, A Random Walk Down Wall Street
, where he argued that it is not only futile, but nearly impossible to beat the stock market averages over the long-term.
Vanguard founder John Bogle, in turn, took these insights and created the first S&P 500 Index Fund, an easy way to track the market's performance with minimal expenses or annual tax consequences.
Much of what Fama, Malkiel and Bogle have done is smart and sensible. You can use their findings to help you a diversified low-cost portfolio for superior long-term growth.
This should be the core of your investing approach. But, ideally, it should not be your entire portfolio. Why? Because there are serious flaws in the "efficient market theory," and you can capitalise on them to create sizeable additional profits.
Yes, the stock market is highly efficient at pricing in all publicly available information. But it is not perfectly efficient. There is a big difference between saying "most stocks are efficiently priced most of the time" and "all stocks are efficiently priced all the time".
If stocks perfectly reflected the business prospects of every public company all the time, you would never have heard of Warren Buffett, John Templeton, Peter Lynch or Carl Icahn. These men have beaten the market by a wide margin over the long haul by taking advantage of inefficiencies in stock prices.
So there you have it, why it is possible to beat the market.