Are We All Active Investors Now?

Markets are always changing — and sometimes the rules of finance do, too. I believe markets are efficient, which means my investment portfolio is pretty much all index funds. My enthusiasm for indexing is based on evidence from the Before Times, when the question of a corporation’s index-worthiness was straightforward. Now there is debate over that question, which raises another one: Are we all active investors now?

First, an important distinction: Believing markets are efficient doesn’t require believing that prices are always “correct.” The efficient-markets hypothesis is just that markets are pretty decent at incorporating information into prices, or better than any alternative.

For this reason, it is very hard to consistently beat the market by picking stocks. Instead, investors should buy passive funds that simply follow an index, like the S&P 500 or the Nasdaq 100. These collections of stocks represent the market as a whole. There are many economic research papers showing that owning all the stocks, based on their size, means less risk and typically higher returns than picking individual stocks. There are no special skills involved, so investors needn’t pay for market research.

Continue reading the entire piece here at Bloomberg Opinion (paywall)

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Allison Schrager is a senior fellow at the Manhattan Institute and a contributing editor of City Journal.