Sunday, January 10, 2010

Efficient Markets or How An Average Beats the Average

Recently, Jason Zweig wrote a Wall Street Journal article titled "Inefficient Markets Are Still Hard to Beat" in which he addressed the ongoing argument of market efficiency and active management. In the article, Mr. Zweig pointed out that even if markets are inefficient, concluding that "...therefore it must be easy to beat the market" is extremely dangerous.

Russell Wermers, finance professor at the University of Maryland, claimed in a February 2009 New York Times article that fewer than 3% of domestic equity mutual funds beat the S&P 500 over a recent 20 year period and that furthermore, it was virtually impossible to guess which funds would be the funds to outperform the indices in the next 20 years.

What is the best way to beat 97% of the domestic mutual funds in the mutual fund universe? Well, the best way may be to buy a cheap index fund. Index fund average returns historically beat upwards of 97% of the active fund returns. Not bad for being average.