Enrich Your Future 32: Trying to Beat the Market Is a Fool’s Errand

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 32: The Twenty-Dollar Bill.

LEARNING: Trade as if the markets are efficient, even though they are not.

“If the markets were perfectly efficient, then no one would discover anything about a mispriced stock. There would be no abnormal behaviors or biases, such as investors preferring to buy lottery stocks; therefore, there would be no incentive for investors to conduct any research. This would make the market inefficient.”Larry Swedroe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.

Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 32: The Twenty-Dollar Bill.

Chapter 32: The Uncertainty of Investing

In this chapter, Larry explains the efficient markets hypothesis (EMH) and why successful trading strategies often self-destruct due to their inherent limitations.

According to Larry, one of the fundamental tenets of the EMH is that in a competitive financial environment, successful trading strategies self-destruct because they are self-limiting—when they are discovered, they are eliminated by exploiting the strategy.

He shares the example of Andrew Lo’s adaptive markets hypothesis, which acknowledges that while the EMH may not necessarily hold in the short term, it does predict that inefficiencies will self-correct over time as arbitrageurs exploit them after publication. This understanding leads us to the inevitable conclusion that financial markets trend toward efficiency in the long run.

Efficient markets rapidly eliminate opportunities for abnormal profits

To demonstrate how the efficiency of markets rapidly eliminates opportunities for abnormal profits, Larry shares the following example:

Imagine that an investor discovers that small-cap stocks have historically outperformed the market in January. To take advantage of this anomaly, that investor would have to buy small-cap stocks at the end of December, before the period of outperformance. After achieving some success with this strategy, other investors would take note—with the large dollars at stake, Wall Street is quick to copy successful strategies. An academic paper might even be published. Since the effect is now known to more than just the original discoverer of the anomaly, one would have to buy before others do to generate abnormal profits. Now, prices start to rise in November. But the next group of investors, recognizing this was going to happen, would have to buy even earlier.

As you can see, the very act of exploiting an anomaly has the effect of making it disappear, making the market more efficient. This underscores the significant role investors play in shaping market efficiency.

Behave as if equity markets are...