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Efficient Market Hypothesis
(Updated 2/10/07)
The Efficient Market Hypothesis (EMH) states that nearly all information about stocks is reflected in their price. What flows from this theory is that investors as a group will earn the market return. So while some investors might perform better, others will perform worse. And indeed, this has been the case. In John Bogle’s book Common Sense on Mutual Funds, he shows a chart of the return distribution of mutual funds before costs.
However as Bogle points out, investors don’t earn the gross return, but the return net of expenses. This is shown in the next chart.
You can read a complete discussion HERE. The above comparison was performed on general equity mutual funds that had a similar composition to the Wilshire 5000 (the Total Stock Market). But similar results were found when comparing mutual funds among similar styles. For example, funds in the large-value category were compared to the large-value index. The following chart shows Morningstar’s 9-square style box and compares mutual funds in each category to their benchmark index.
Source: Vanguard.com Now you may say, “But I’m not going to pick just any fund. I’m going to pick a fund with a superior track record.” Sadly, this strategy may not work, either. The odds of winning funds to continue their winning ways diminishes over time. For example, of the funds which outperformed for a decade, many of them failed to outperform in the following decade. Click HERE to read more. As a final thought, I will leave you with the words of Benjamin Graham. This is what Graham replied in an interviewed conducted in the 1970’s:
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