While the news has recently given us lots of evidence that even large and liquid markets aren’t fully efficient (and that’s before the liquidity disappears), I learned something very interesting about the efficient market theory while reading The Snowball. It appears that several proponents of the theory more or less tried to publicly disprove Warren Buffet’s investment results after the fact. It’s hard to believe a theory that doesn’t allow for the existence of Buffet.

Since then I’ve read Irrational Exuberance by Robert Shiller, which also has several warning about how efficient capital markets really are. It appears that only a perfect market where everyone knows everything would really be efficient. Even expecting good efficiency most of the time may be a bit too much for current markets.

While this may not mean a lot to the average mutual fund investor it’s clear that anyone who wants to develop their own investment plan can’t build it on the idea that investments are always bought and sold at the “right” price.  For those drawn to stock picking this is good news, since it means they can in theory expect the market to misprice assets (perhaps more commonly that most people believe).

I’m not a stock picker – for something involving that much work I’d rather be involved in the business itself – but this does give more importance to my earlier post about changing asset allocations in light of long-term trends.

In some very weak forms you can consider the market to be efficient. If you don’t want to spend a lot of time managing your investments then regularly buying index funds will give you something close to an efficient market, although it’s still not perfect. But if you really want to get into the details it seems like there’s no way you can assume the efficient market hypothesis is always right.