Efficient Market Theory and ETFs

One of the most popular ideas in the investing world, the Efficient Market Theory, argues, very simply, that a stock’s price equals its value. This would mean that a stock’s price reflects all publicly known data, including future expectations of the stock’s performance.

This is, of course, just an economic theory. What does it mean for you and your investment strategies? While this certainly isn’t true 100 percent of the time, in today’s world of instant information, it is fairly difficult for the average investor to find an undervalued stock, or a specific stock to successfully short. For example, if a newspaper or a magazine suggests that readers buy a certain company now, it is likely that the readers are too late to capitalize on the investment. Maybe the publication’s sources tell them that the stock is undervalued, or that the price will double because of X, Y and Z. By the time the information, already ancient just a few short hours later, is in the investors’ hands, the stock should already have this information incorporated in the current price. The information could have even changed entirely.

Granted, there are anomalies. Consider Enron for example. Bethany Mclean, columnist for Fortune Magazine, looked at Enron’s financial reports and discovered that they were overpriced at their peak. Mclean questioned Enron’s inflated stock price and wrote an article in Fortune entitled, “Is Enron Overpriced?”. If she, or anyone for that matter, had continued to look into the unclear revenues the books showed, they probably would have sold their stock before the scandal hit full swing.

However, a normal investor will probably not take the time to dig through each company’s annual reports, analyze ratios or read the disclosure notes to find these price discrepancies.

Picking out individual stocks can be time consuming, risky and difficult to do without complete information. Of course, the individual investor still usually wants to invest in the stock market. There are ways to do this that are both safe and profitable.

At Wiser Wealth Management, we invest in Exchange Traded Funds (ETFs). ETFs track indexes, such as the S&P 500, and trade on the stock exchange. An ETF is similar to a mutual fund in that it is a combination of stocks, but that’s where the similarities end. Our ETFs do not come with a slew of broker commissions for unnecessary trades or mysterious 12B-1 fees. ETFs insulate the investor from company-specific risk and provide a simpler, more practical way to invest.

Article contributed by Paige Slusser

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