Don’t Bother Picking It Up

I’m not saying that the efficient market theory is incorrect, that modern portfolio is dead, or that indexing/passive investing is the wrong way to invest.

I agree 100 percent with what you say in the article, Carl.

But I take it a step further. I do indeed say that the Efficient Market Theory is incorrect and that Passive Investing is the wrong way to invest. I say that the idea that the market is efficient has caused more human misery than any other mistake every made in the history of personal finance. We are going to see millions of busted retirements as a result of this mistake. There's a good chance that we are going to see an economic depression. If we see an economic depression, the continued viability of our political system is going to be called into question. The stakes could not possibly be larger.

I didn't start out believing this. I discovered it as the results of asking Some Questions That Are Not to be Asked. The more I have studied the matter, the more convinced I have become that the Efficient Market Theory is not a little off the mark, it is wildly off the mark. I have brought this matter before a good number of big name "experts" (John Bogle, William Bernstein, Bill Bengin, Jonathan Clements, Larry Swedroe, Rich Ferri, Scott Burns, Micheal Kitces, Bill Schultheis). Not one has been able to give convincing responses to perfectly reasonable questions.

Several have indicated that a good number of today's financial planners are aware that the conventional investing wisdom of today needs to be replaced. Scott Burns offered the best explanation of why this has not been done in the 28 years since the academic research began to show the holes in the theory: "It is information that most people don't want to hear." The "experts" urge Passive Investing not because it stands up to scrutiny but because it is comforting to people who have gone with excessive stock valuations at times of insanely high prices to be told that they did nothing wrong in doing so.

Today's investing advice is not serious. It's marketing-driven, not research-driven (the research that is employed is there to serve marketing purposes). Rob Arnott said it well when he observed that most of today's conventional investing advice is the product of "myth and urban legend." There is no "there" there.

The mistake came about when the academics were trying to figure out why stock returns are not predictable in the short term. There are two possible explanations. One is that the market always gets the price right and therefore it is impossible for any investor to outsmart the market. The other is that the market is so emotional that short-term prices can be just about anything; therefore; no amount of intelligence can give an investor an edge. The academics guessed that it was the first explanation that applied. The research of the past 30 years show that it is really the second explanation that applies.

The difference is critical because, if the second explanation applies, long-term timing is not only possible but required for anyone who wants to succeed as a long-term investor. If the second explanation applies (there is today a mountain of evidence that this is so), Passive Investing is the worst strategy that could ever be conceived by the human mind (it encourages investors to ignore price, which determines the long-term return that they obtain from their stock purchases).

Oops!

Rob

Here is a piece where I gave my take on the EMH and the $20 bill:

http://alephblog.com/2007/07/02/efficient-marke...

A very little humor to go along with a serious subject.

It is my understanding that EMH holds true only when a minority of investors are using a passive strategy. If everyone else is carefully reviewing the data and readjusting their portfolios when things get over/undervalued, then you can afford to sit back, let them do all the work, and invest passively. The problem comes when everyone else is investing passively too. Then nobody is doing the work. Imagine if *everyone* just bought index funds instead of individual stocks - valuations would never change to accurately reflect the data. It seems that we're now close to that point, given the rise of 401k's, where the majority of Americans just automatically pour money into mutual funds (many of them being index funds) each month. The work of valuing stocks is left up to just a relatively small group of fund managers. The point of the $20 bill story is that someone has to be the first to recognize the bill, and bend over to pick it up, in order for EMH to hold true. When only a handful of people are doing proper valuations, the likelihood that a long time will pass before someone sees the $20 bill increases dramatically.

"We ought to take the time, especially those of us that are managing money for other people. We ought to take the time to question the underlying assumptions."

No disrespect intended from my comment, but this should be a "requirement" for those actively managing money for other people.

If an individual investor can easily invest his/her money into a low-cost, passively-managed and diversified index fund without the added costs of a money-manager, then the only reason one would have for hiring a money-manager would be to try to outperform that same index fund. How else would one justify the added costs of his/her services to a client without being hypocritical?

@guzzo- no offense taken. Amen. That is exactly my point, we have a
responsibility to keep turning over rocks. To a large degree it is
what we get paid to do.