What is "market efficiency," and why does it matter?

"Market efficiency" is the theory that stocks are priced properly, as their values at all times reflect all the information that is known by all investors worldwide.

Does it therefore follow that all stocks are perfectly priced all the time?  The answer is NO.  Sometimes bubbles happen, and we can see in retrospect that the market prices of stocks were wrong.  The theory of market efficiency is not nearly as strong as we once believed.

And that is where active investors draw their inspiration, that stock prices are often wrong, and that they can find undervalued or overvalued stocks, to achieve higher returns.  However, refer back to the first sentence of this section ("as their values at all times reflect all the information that is known by all investors worldwide.")  So, for market prices to be wrong, you have to believe that all the other investors in the world are wrong.  Basically, for you to find an undervalued or overvalued stock, you have to believe you have better information, or better or faster processing of information, than everyone else in the world combined.  That is an extremely tall order!  And so we as a firm stay away from engaging in strategies where the odds are heavily stacked against us.

But if you still believe that you can find undervalued and overvalued stocks, please go ahead and try your hand at active management.  If not, use passive investing, and not the efficient markets work FOR you.