What is one of the best first steps you can take to becoming a better investor? Embrace the power of market pricing.
Me and You Against the World
If you look at all the stock trades placed by all of the world’s traders in 2014, the daily average trading volume exceeded $300 billion. That’s a daily trading average, mind you. With the collective wisdom resulting from that much money flowing in, out and throughout the market every day, it’s no wonder that global markets can process new information with lightning reflexes, incorporating it into new pricing almost instantly.
This level of efficiency makes it extremely difficult for individual investors to ever know more than the market already knows. Given the transaction costs involved, it’s even tougher to use that knowledge as a trading advantage.
It’s not only individual investors who face steep hurdles against beating the market at its own game. Analyses like the S&P Dow Jones Indices annual SPIVA® U.S. Scorecard illustrate how few active fund managers are able to outperform their benchmarks most years, and how those who do are unlikely to consistently sustain their outperformance over time.
The implications for investors are huge.
Outperformance? Be Skeptical
First, you need to treat outperformance claims very skeptically. There is clear evidence that trying to beat the market through stock picking or market timing more closely resembles wagering with your hard-earned money than investing it toward lasting wealth. While it is possible to measure the expected return of your portfolio through careful structuring, trading and timing is unlikely to provide long-term benefits.
Breaking News? Don’t Let It Break Your Resolve
Second, recognize that any information you see in print, on the internet or broadcast on the television is already reflected in stock and bond prices by the time you see it. For that reason, you are likely better off managing your investments as if market prices were always right.
If you are skeptical, consider these words from Professor Eugene F. Fama, who was awarded a Nobel prize in economics for his lifetime of work on asset pricing: “The efficient market theory is one of the better models in the sense that it can be taken as true for every purpose I can think of. For investment purposes, there are very few investors that shouldn’t behave as if markets are totally efficient.”
Want to be a better investor? Let evidence-based investing guide the way
By giving up on trying to outperform the market through trading and timing strategies, you are taking an essential first step toward more effectively capturing the market’s available returns. Replacing forecasts and fickle fortune with evidence-based strategies such as discipline and diversification, you are much more likely to find your way on the road to financial freedom.
Our website has a wide variety or resources designed to shed light on this and other important investment concepts. We hope that you find it helpful. In addition, feel free to email me with questions.