Speaker #0When it comes to investments, everyone tries to figure out if there are ways to beat the market. But the real question to ask is, is it truly possible, or is the market always one step ahead of us? The theory that the market will always be ahead of us has been defined as the efficient market hypothesis, developed by the economist Eugene Fama, who, by the way, won a Nobel Prize for this work. According to this theory, markets should be considered efficient. This means that the price of, for example, a stock already reflects all the information currently available to any type of investor. As a result, predicting the market and consequently beating it is essentially impossible. More specifically, the key principle is that the prices of all market assets are already determined by available information. Therefore, every time there is a price change, whether an increase or a decrease, It means that new information has emerged, and thus, there are essentially no opportunities for arbitrage. Similarly, this implies that outperforming the market without excessively increasing risk is practically impossible, at least in the long run. So, what does this mean for us individual investors who do not work for major Wall Street banks? First, it opens up a debate on the skill or luck question. If markets are efficient, The logical consequence is that beating them does not primarily require skill, but rather luck. At least statistically speaking, in most cases, those who beat the markets in the long run are either extremely skilled or extremely lucky. Likewise, this theory suggests that making predictions about future prices is inherently difficult. This means that watching videos about Tesla's future stock price, or any other stock, is pointless because ultimately, no one truly knows. These videos are often made just to get more views, attract more subscribers, and possibly sell courses. At the same time, the efficient market hypothesis implies that it is difficult to assess stock prices in a way that deviates significantly from their current price. In other words, beating the market in the long term without taking on significantly higher risks is essentially impossible. This is further confirmed by Spiva. a research division of Standard & Poor's that evaluates the performance of active funds versus passive funds on a global scale. According to the latest scorecard, 93% of actively managed equity funds underperformed the index over a 10-year period. This raises an important question. Does it make sense to invest in active funds hoping to be in the 7% that outperforms the benchmark, such as the S&P 500? This is a question worth considering. However, the efficient market hypothesis is, as the name suggests, a theory and thus cannot be scientifically proven with absolute certainty. There are indeed criticisms of it, such as the existence of financial bubbles. If markets are efficient, one might ask, why do bubbles exist? Throughout history, we have seen many bubbles, such as the tulip mania, the dot-com bubble of the 1990s, or the housing bubble that led to the great financial crisis of the 2000s. More recently, the cryptocurrency market in 2017 and 2022 could also be considered bubbles, although this market has partially recovered. Some critics argue that if markets are efficient, how can bubbles exist? According to the efficient market hypothesis, bubbles can only be identified retrospectively. That means it is difficult, if not impossible, to predict that we are in a bubble and that it will eventually burst, because the current price of assets already incorporates all available information. This does not mean that the information is flawed or misinterpreted by market participants. This brings us to the key point of this discussion. If markets are efficient, does it make sense to actively invest, or is it better to simply follow the market? According to this theory, for most investors, since markets are efficient, it makes more sense to follow the market rather than try to beat it. This opens the debate between passive investing and active investing, which have very different characteristics. Briefly, in passive investing, one follows indexes such as the MSCI world or the S&P. This approach is highly optimized in terms of fees, since index funds tend to have very low costs and require minimal trading activity, making them tax-efficient. Passive investing is also focused on the long term. Active investing, on the other hand, aims to beat the market, but as we have seen, it almost never succeeds and comes with much higher fees, which, as we will see, have a more significant impact than one might think. For example, considering a 20-year investment, a €10,000 investment in a passive ETF with a 0.2% fee and an actively managed fund with a 2% fee will yield very different results. Assuming an 8% annual return after 20 years, the passive investment would be worth $46,000, while the active investment would only grow to $32,000. This results in a $13,000 or 13,000 euro depending on the currency used, difference due solely to the choice of fund. So, what does this mean for individual investors? Mainly that investing should be primarily passive. Investors should remain disciplined and avoid emotional decisions as these can destroy everything they have built. It is also important to be aware of our cognitive biases and try to minimize their influence. For most investors, a passive strategy is likely the most optimal one. And remember, costs have a huge impact over the long term. Therefore, it is essential to have the humility to accept that the market is efficient, that we probably won't be able to beat it, and that the best approach is simply to go along with it.
