The Advice Remains the Same: Markets Are Efficient

(Note: This item is part one of a series on why you shouldn’t alter your investment strategy during booms or busts.)

Whether the market has gone up (as it has during the past two years) or down (as it has during the past several weeks), my investing advice has not changed: [buy the market, diversify systematically, minimize taxes and turnover, think long-term, apply discipline, hold low-cost funds and maintain asset allocation].

A common refrain from investors has gone something like this: “Yes, that advice has worked in the past. However, this time is different. It obviously isn’t working now! The market just keeps going down and down. There must be a better alternative than to sit and do nothing.”

In the next few posts, I want to explain why my investing advice has not changed, even though many others may believe “this time is different.”

Market efficiency

For us to believe that we should abandon a long-term, buy-and-hold strategy, we would have to be first convinced that markets were no longer efficient. In other words, the market was now mispricing assets and was slow to react to new information.

It is hard to imagine that markets have gotten slower at reacting to news. In fact, markets incorporate news into prices almost instantaneously. After Treasury Secretary Timothy Geithner unveiled the Treasury Department’s plan to clean up toxic assets, the market reacted immediately, as evidenced by several indexes leaping to their highest one-day gains since last fall.

We see no evidence that active managers were able to predict (the then) bear market. In fact, while there was a wide dispersion in individual stock returns (some stocks, like Wal-Mart were actually up), almost every single diversified mutual fund produced large losses. This would not be the case if markets were somehow inefficient. It is also important to note that evidence shows that active managers fail to outperform during bear markets.

We believe that the market was and continues to be highly efficient. It is just that the news has been persistently worse than expected, causing prices to fall. This is what causes bear markets.
In my next posts, I’ll give further explanation of why my investing advice is still valid, including a discussion of market timing.

Article by Larry Swedroe, Wise Investing, April 9, 2009.  Used today by Matt McKinney (italics his) because the same could be said during most if not every downturn in the market and the pessimism (or noise) in the media that follows.