Flaws of Efficient Market Theory

Comments on “The Traits and Processes That Lead to Better Forecasts,” an interview with Philip Tetlock, in the September 2016 AAII Journal.

An excellent article. It mentions the efficient market theory in passing. I have always believed this theory to be a fallacy. Tetlock teaches me the technical terms to describe why.

Efficient market theory is all epistemic, like Einstein. It assumes that each investor, presented with the same facts, will act the same. This ignores the investor’s time frame, volatility tolerance (I do not equate volatility and risk; sorry, Mr. Sharpe) and other factors including investment style.

A momentum investor and a value investor will make different decisions even when presented with the same facts. Price is set by supply and demand through the auction process. In any auction, the winner “overpays” in the opinion of all other participants. Success is perhaps achieved by overpaying the least when buying. Efficient market theory can’t handle this.

John Maynard Keynes likened investing to judging a beauty contest, except that the object was not to pick the most beautiful girl, but to pick the one the other judges would choose. Of course, they are playing the same game. Again, this argues against efficient markets. Remember: “The race is not always to the swift, nor the battle to the strong, but that’s the way to bet.”
—Pete Stoehr from New York

Buffett’s Strategy for Heirs

Comments on “Retiree Portfolios and Warren Buffett’s Allocation Instructions,” in the Briefly Noted column of the September 2016 AAII Journal.

Buffett’s brilliant.

His surviving family members can easily get by just off dividends from an S&P 500 index fund, even if it gets cut in half during the next economic crisis. They won’t panic, and they won’t have to sell at the very worst time.
—Mitchell Meyers, U.S. Armed Forces Europe

If withdrawals are made from the short-term bond fund in the years that the market was down the previous year, the concept is the same as Jim Cloonan’s “Investing at Level3.” Exactly the same: Have a small, safe pool to withdraw from in down years and put all the rest in equities.

Jim Cloonan and Warren Buffett think alike.
—Gordon Robinson from North Carolina

Following Bernstein’s Investing Wisdom

Comments on “Investing to Avoid the Consequences of Being Wrong,” by William Bernstein, in the September 2016 AAII Journal.

As a retired 84-year old, I have had a successful professional and investing experience, each for over 55 years. The interview with Dr. Bernstein, and particularly the ending recording, summarizes to a “T” the basis of my financial career! I wish my children and grandkids would heed his advice: Save as much as you can, invest diversely 100% in stocks and avoid all bonds.
—George Sturgis from Mississippi

I have been retired for 18 years, and when I retired I changed my portfolio allocation to 35/65 stock/bonds. I rebalance whenever the allocation approaches 45/55. When I turned 75 I stopped rebalancing, as my bond portfolio was enough to live on and kept me from panicking in 2008. While my friends rush to pluck those nickels in front of steamrollers and rush from guru to guru, I am content to live my middle-class life and enjoy my family.

I have bought and given to friends and family at least a dozen copies of Bernstein’s “The Four Pillars of Investing.” That, along with Burton Malkiel’s “A Random Walk Down Wall Street,” are my two favorite investing books. My only advice, besides reading the above books, is to never forget that risk and reward are joined at the hip; you cannot separate them no matter what some expert tells you. One other thing is to know your fees/expenses; I keep my mine under 0.4%.
—David Levine from North Carolina