Personal Money Management 101

Picking Stocks and Shares

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  • Efficient Markets
    • Efficient market theory says the current price of any stock is its right price as it reflects all public information about that stock and the economy in general.
    • Future price movements are effectively a random walk
      See homepage of Burton G Malkiel, author of the classic A Random Walk Down Wall Street.
    • The financial sector is extremely efficient with many highly skilled analysts scrutinizing companies and the economy with fine tooth combs.
    • Any mis-priced stocks would quickly be arbitraged back to their true levels.
    • Thus it is impossible to consistently beat the market.
    • But...
      • how come markets sometimes undergo sudden corrections (crashes)?
      • how come some individual investors, eg Warrrn Buffet, do beat markets - sometimes spectacularly?
      • arrow anomalies can & do occur, but are difficult to exploit.
    • In practice fund managers don't beat markets. In fact, managed funds tend to underperform once fees are deducted. For example:
        • "Research from independent advisers Bestinvest shows that over the past three years 73pc of actively managed funds nvesting in UK companies to increase your capital have failed to beat the FTSE All Share Index." (Daily Mail (Oct 25, 2006)
        • Clive Briault of The United Kingdom Financial Services Authority says: " Our research shows there is no evidence, on average, over time, that actively managed funds outperform tracker funds if you take into account the difference in charges between the two." (The Mail on Sunday, Financial Mail, January 28, 2007)
        • Corollary: Managed funds are bad for your wealth!
    • If efficient market (or random walk) theory is right, and the evidence suggests it is, you (or expensive fund managers) can't beat the markets arrow so it's best to simply put your money into low-cost tracker funds (those which simply track an index rather than actively try to beat it) and leaving it there for some time.
    • Of course you can still supplement core tracker holdings by following your personal hunches and backing individual sectors - or stocks. Maybe you'll be right!