Daniel Solin has a column at BloggingStocks extolling the virtues of index funds, which is all well and good. But the argument he uses to get there is odd:
All information about listed companies is public. It is widely and instantly disseminated. This information is studied by millions of investors, who establish the price of a given stock based on this data.
Many of those looking at this data are professional analysts. They are well trained in finance and have access to powerful computer programs that assist them in crunching the numbers.
There is one piece of information they don’t know: tomorrow’s news.
Future events move stock prices. The market has already discounted for current news.
This is a very strong version of the efficient markets hypothesis, and anybody with an eye on the stock market’s massive swings of late know that it’s bullshit. Stocks move all over the place on no news at all, every day.
But you don’t need to believe in the efficient markets hypothesis to come to the conclusion that investing in index funds is a good idea; you can think that even if you’re a strong believer in alpha. Solin himself demonstrates that:
Of the 500 companies that made up the S&P 500 in 1957, only 74 of them were in the index in 1997.
Here is the real kicker: Only twelve of those companies outperformed the S&P 500 index in the period from 1957-1998.
The fact is that the S&P 500 itself outperforms the market, largely thanks to its survivorship bias. If you can buy an index fund and keep track with the S&P 500, you’re ahead of the game already. If you think that you can outperform the S&P 500, you’re basically saying that you have truly extraordinary alpha-generation abilities. Most people are happy to admit that they don’t have those abilities — and that’s a much easier way of getting into index funds than feeling that you need to buy in to the EMH first.