In an efficient market, investors should consider investing in index funds and passively managed portfolios to avoid high fees and attempt to match the performance of the broader market. Exchange-traded funds (ETFs) are a cost-effective option that tracks performance across a broader index. Predicting future stock market performance is unlikely in an efficient market.
Professional investors in the financial markets are likely to adhere to specific strategies which, if successful, lead to the desired returns. Typically, these strategies involve buying stocks that are believed to be worth more than those where investors are currently valuing these investments based on market prices. In an efficient market, however, the theory is that securities reflect true values based on all available information and factors available to investors. To invest effectively in what is thought to be an efficient market, investors might consider betting on a broader market by investing in index funds and passively managed portfolios.
In an efficient market, since all available news and economic factors have already theoretically been priced into stocks, there is little possibility of predicting future stock market performance. That’s because an efficient market eliminates the possibility that investors aren’t yet rewarding a company for profit prospects or that another stock is being unfairly punished by investors for an event. Without the ability to predict future activity, it may make more sense to avoid investing in mutual funds and other investment vehicles that carry high fees. Instead, in an efficient market, investors might consider choosing funds designed to perform in line with broader markets rather than attempting to beat the performance of the broader market.
Passively managed mutual funds are investment vehicles designed to produce similar returns to another barometer. The professionals who manage these funds do not make frequent changes to the composition of the fund as opposed to an actively managed portfolio where the fund managers buy and sell stocks at will in hopes of outperforming the markets. The fees associated with passively managed funds are more modest than actively managed funds charge, and in an efficient market, it may make more sense to choose the former.
Exchange-traded funds (ETFs) are a type of mutual fund, although these investment vehicles are designed to track performance across a broader index. Investors looking to buy oil services stocks, for example, can invest in an oil services ETF that has the same composition as the industry standard oil services index. The stocks in the index can be the largest oil-service companies or mid-sized stocks, but in either case, the ETF’s performance is tied to the makeup of the industry barometer, and changes to the index are rarely made. Again, cost is the motivation for selecting ETFs over actively managed mutual funds or even individual stocks. If, as is the case with an efficient market, there is no margin for error in stock price assessments, then choosing the most cost-effective investments that will at least produce returns no worse than global markets may be the best strategy.
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