First of all, thanks to everyone who tuned in to CNBC to watch The Millionaire Inside this weekend. If you're new to Rule #1 investing, try taking a look through my FAQ to get familiar with the concept of buying $1 for $0.50 (buying companies on sale, as I discussed on the show).**
This week's reader-submitted Question of the Week comes from Alex. It's a long one about EMT (Efficient Market Theory), which I talk about at length in the opening chapters of Rule #1. [Edited for length.]**Q:
Dear Phil Town,
It just so happens that malkiel's book is my favourite investment book. i think his idea that novices should buy cheap index funds & be done with active mutual funds is sound. After all some indexes, especially of emerging markets, make more than 15 per cent in the last couple of years.
I believe the global market conditions have changed so much from graham's time that his idea really kind of merges with the EMT, at least the weak version. OK, Malkiel used to believe in the strong version of EMT but now subscribes only to the weak or semi-strong version.
Markets today are probably more efficient than they were in graham's day, at least in the sense that information is more readily available than ever. And some markets are more efficient than others, just as famous stocks tracked by an army of analysts would pretty much have all the available market info reflected in their prices, as opposed to obscure ones which few people bother to analyse.
But your joke about the EMT professor who didn't believe there is a $100 bill in front of him on the pavement cuts both ways. In a deeper sense - in the sense of the semi-strong version of EMT, it really doesn't pay to try to make a killing or make a living by going around looking for $100 bills, so the prof is right in a deeper sense.
In the same way, it's actually extremely tough to beat the market, not one or two years but consistently over years & years, i.e., it's gonna be tough making a living by looking for mislaid $100 bills or bargain stocks consistently over years. Statistically, there are bound to be one out of several millions of people who manages to make a decent living out of picking up $100 bills in the streets, just as there are bound to be a Graham & buffett out of millions & millions of stock investors.
I believe if one did a survey on your students & followers over a long period of 5 - 10 years or longer (those who have the discipline to stick to Rule #1 day in & day out), i'd bet they would not do much better than buying good old fashion index funds.
Rgs,
Your fan,
Alex Lo, from Hong Kong
A:
Hi Alex,
I think you should stick to what you like. Warren Buffett said that those of us who see mispricing in the market every day have to hope that the business schools keep teaching EMT. If the guys you are competing with don't know the difference between price and value, the game is weighted heavily in favor of those who do.
And if you think picking a stock to go up is difficult, I think you are likely to find that picking an entire sector or even an entire market is quite a lot harder. We don't have to know what market is good or bad or what sector is hot or cold. We only have to know that the business is wonderful and that it is on sale big time.
The only way to avoid picking something (a stock or a sector or a market) is to pick all of it -- to buy the whole index, as Malkiel suggests. But then you have to be sure to NOT remember that the US market's index rate of return has been zero or less from 1905-1942, 1965-1983 and from 2000-2007. And if we are in one of those long sideways markets, Mr. Malkiels ETFs are going to deliver a zero rate of return for many more years to come.
And rather than have me rehash Buffett's response to your argument, Alex, could I suggest you read his annual reports and see if Mr. Buffett can convince you?
Now, Alex, quit thinking so hard and go play!
