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What Are the Best Tips for Investing in an Efficient Market?

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  • Written By: Geri Terzo
  • Edited By: PJP Schroeder
  • Last Modified Date: 26 August 2016
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Professional investors in the financial markets are likely to adhere to specific strategies that, when successful, lead to the desired returns. Typically, these strategies involve buying securities that are believed to be worth more than where investors are currently valuing these investments based on the market prices. In an efficient market, however, the theory is that securities reflect true values based on all of the available information and factors available to investors. To invest effectively in what is believed to be an efficient market, investors might consider betting on the broader market by investing in index funds and passively managed portfolios.

In an efficient market, because all of the available news and economic factors have theoretically been priced into stocks already, there is not much of an opportunity to predict future stock market performance. This is because an efficient market removes the possibility that investors are not yet rewarding a company for the profit outlook or that another stock is being unfairly punished by investors for an event. Without an ability to predict future activity, it may make the most sense to avoid investing in mutual funds and other investment vehicles that carry with them high fees. Instead, in an efficient market, investors might consider choosing funds that are designed to perform in line with the broader markets rather than to attempt to beat broad market performance.

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Passively managed mutual funds are investment vehicles that are designed to produce returns that are similar to another barometer. The professionals who manage these funds do not make frequent changes to the makeup of the fund as opposed to an actively managed portfolio where money managers buy and sell securities at will in hopes of outperforming the markets. Fees associated with passively managed funds are more modest than what actively managed funds charge, and in an efficient market, it may make the most sense to choose the former.

Exchange traded funds (ETFs) are a type of mutual fund, although these investment vehicles are designed to replicate performance in a broader index. Investors who seek to buy oil services stocks, for instance, may invest in an oil services ETF that has the same makeup as the industry standard oil services index. Stocks in the index may be the largest oil services companies or mid-sized stocks, but either way, performance in the ETF is linked to the makeup of the industry barometer, and changes to the index are made infrequently. Once again, cost is the motivator for selecting ETFs over actively managed mutual funds or even individual stocks. If, as is the case in an efficient market, there is no room for error in the price valuations of stocks, then choosing the most cost-effective investments that will at least produce returns that are no worse than the overall markets may be the best strategy.

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