The efficient market hypothesis holds that financial markets digest (and reflect) any information that might reasonably provide clues as to the true value of an investment so quickly that one cannot consistently outperform the market on a risk-adjusted basis.
In other words, under the efficient market hypothesis, market prices are thought to instantaneously reflect all available information. The end result is that all investments are fairly valued, and that any outperformance by an individual investor is due either to random chance or to the investor taking outsized risks.
Whether or not our financial markets are truly efficient, I’m convinced that they’re efficient enough that I don’t have the time, information access, or skill to outperform them. That’s why our portfolio is composed of index funds that seek to replicate the performance of the market while minimizing costs.
Today, while wandering around Disneyland, I was struck by the extent to which information flow begets efficiency. In case you weren’t aware, there are now smartphone apps available that allow users to share information on wait times at different attractions (see, for example, here).
Gone are the days when you could be mindlessly waiting for an hour to board It’s a Small World back in Fantasyland while others are enjoying ridiculously short wait times at Space Mountain up in Tomorrowland. You’re now never more than a click of the refresh button away from complete knowledge of what’s happening everywhere in the park.
This means that people will quickly discover and flock to “undervalued” rides, thereby correcting any wait-time inefficiencies. The same, of course, is true of financial markets. Investors (as a whole) are quick to react to any relevant news and correct the prices of undervalued (or overvalued) investments.
The point here is that information access begets efficiency. And information has never been more freely or quickly accessible than it is today.
The next time you think you have some great insight into the next big thing, ask yourself if it’s to think that you’re the only one with access to that information. Chances are it’s already priced into the market.