Invest as if Markets are Efficient

[T]hose who disagree with market efficiency simply assert that it stands to common sense that greater effort to get facts and greater acumen in analyzing those facts will pay off in better performance… By this logic, a cure for cancer must have been found by 1955.

— Paul Samuelson, Nobel Laureate in Economics

At a neighbor’s garage sale, you notice there is a Babe Ruth rookie baseball card on sale, priced at 25 cents. Obviously, your neighbor is not a big baseball fan, since this card is worth tens of thousands of dollars.

Just as you are about to hand over a quarter, another neighbor walks up. She also knows the value of the card is way more than 25 cents and offers $5. Pretty soon, you and your neighbor are having a bidding war, until the price you pay for the card is close to its actual value. And it only took one additional participant to get there.

Financial markets work similarly on a larger scale, with millions of investors buying and selling securities each day to determine fair market value.

Because markets usually do a good job incorporating all publicly known information into prices investors are better off acting as if current prices are correct instead of trying to guess their future direction. This also allows you to focus on your overall plan instead of trying to predict how markets will react to news on a particular stock.