Dynamic Wealth Management Efficient Market Theory

Dynamic Wealth Management Efficient Market Theory

Dynamic Wealth Management: A branch of economic thought known as ‘efficient market theory’ hypothesizes that the stock market is almost perfectly efficient in the sense that asset values are almost perfectly priced when factoring in all known information. Taking this theory to the extreme would mean that a monkey randomly choosing stocks would do no better or worse on average than a Wall Street guru.

Many people subscribe to this theory. Their main reasoning is that there are so many knowledgeable people that actively invest in stocks (think head fund managers, mutual fund managers, private equity guys, etc.) that all stocks are accurately valued. The only way to make more money in the stock market, or any aasset class for that matter, is to take on more risk. Otherwise, it’s futile to attempt to try to pick stocks since you won’t find any good deals (other people would have already found them and bid up the stock’s price).

People who believe in this theory generally just invest in broad, index funds with low expense fees. They attempt to diversify to mitigate risk (hence the appeal of ETFs or index funds) and also attempt to lower transaction costs (again, the appeal of ETFs). By investing in ETFs and index fund, they also can just park their money in the long-run, which will limit their tax liability.

The market does a pretty good job at accurately pricing stocks, and on the whole, most investors probably can’t beat a random monkey choosing stocks. But efficient market theory can’t explain why some investors consistently beat the market, such as legendary investors like Warren Buffet and George Soros. It is also stretch to think the daily gyrations of the stock market are completely rational.

It is also difficult to explain the tech boom of 95-99 and subsequent crash in 2000-2002 through efficient market theory, since this was a pretty clear episode of excessive investor exuberance for tech stocks.

Also, while there is a lot of .smart money. in the market, this ‘smart money’ is often handicapped by large asset bases. Most of the best investors have asset bases of 0 million+ to deal with, so they cannot put much of their funds into the stocks that they necessarily think are the best buys.

For example, if a hedge fund manager who manages 0 million thinks a company with a market capitalization of 0 million is a great buy, he cannot put much of his asset base in their physically. If he invested all of it, he would have bought the company! That, plus with a sizeable infusion of money would have bid the stock.s price up way past its value.

Furthermore, as much smart money is out there, there is also a lot of dumb money too. Plenty of people don’t know what they.re doing, and they trade based on emotion, leading to bad investment decisions. It is for these reasons that while efficient market theory has its merits, it’s a huge stretch to believe that today’s financial markets are almost completely efficient.

Dynamic Wealth Management: Investing in your priorities

A socially responsible strategy allows individuals to invest in a way that is consistent with their own priorities. As indicated by performance in recent years, choosing to invest in this manner does not mean sacrificing potential return. However, not all investments will perform in the same way.

If this method of investing interests you, work with your Dynamic Wealth Management financial advisor to learn more about how SRI options can work in conjunction with your overall investment strategy. There are a number of mutual funds to choose from that can be incorporated into an existing or proposed asset allocation strategy. Alternatively, you can select specific investments that fit more particular criteria or apply your own social screens to your managed portfolio. Be sure to consider how any investment you choose matches your risk profile and your return expectations.

The most effective approach to socially responsible investing is to make sure that the execution of the strategy is consistent with your overall financial plan. Your DWM financial advisor can help you review your current asset allocation and help you consider whether social investing is right for you

 

Here at Dynamic Wealth Management we are committed to offering our clients access to the latest and broadest range of financial services and products on the market. We know that choosing the right strategy, the right investment and the right product is no easy task in this day and age! Whether its advice, investments or financial planning we are here to answer all your questions and facilitate all your financial needs.

 

 

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