Does Warren Buffett believe in the Efficient Market Hypothesis?

More lessons from Warren Buffett(Part Two)

Aaron Watson
Feb 24, 2017 · 3 min read

If you missed it, check out my first post on lessons from Warren Buffett’s annual letters to his shareholders. This is a continuation of that exercise.

As one of the greatest investors of the modern age, Warren Buffett has masterfully cultivated a Midwestern, folksy personal brand. The Berkshire Hathaway annual meeting and letters to shareholders serve this purpose, in addition to distilling wisdom and business advice to anyone caring to pay attention.

This does not always align with his business practices. The Financial Times recently outlined a failed takeover of Unilever by Buffett and his occasional partner, 3G Capital. As with all things, a dose of skepticism is welcome and warranted in analyzing the advice from experts.

Source Material

I am summarizing Buffet’s perspective from reading The Essays of Warren Buffett, arranged by Lawrence Cunningham. This collection of letters to Berkshire Hathaway shareholders over the company’s history, are all written by Buffett and offer an MBA’s worth of insight for $20.

Efficient Market Hypothesis Malarkey

The efficient market hypothesis is an investment theory that teaches students it is impossible to “beat the market” because the stock market is perfectly efficient.

The theory says stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. This should make it impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Disciples of EMH preach buying a diversified basket of investments, often indexes and ETFs, and holding them for a long time horizon.

Buffett, along with many professional investors dispute this claim. He even goes so far as to thank the academics who continue to teach this concept to their students. Buffett says he has benefitted from competing against “opponents who have been taught that thinking is a waste of energy”.

This can be difficult to interpret for folks who do not possess a high degree of financial literacy.

It becomes further convoluted when you learn Buffett bet a hedge fund that a collection of index funds would outperform an actively managed group of funds.

If all of Buffett’s success has been in direct contrast to buying index funds, why place this bet?

Because Buffett knows how hard it is to do what he has done. It takes an enormous amount of patience, a grinding discipline, and access to information that many are not privy to receiving.

For every Buffett successfully investing actively, their are dozens who’ve squandered their savings on ill-advised, specific investments.

Embedded in his critique of Efficient Market Hypothesis, is the acknowledgment that no information is perfectly distributed across the population. Additionally, the general population is highly susceptible to a herd mentality and groupthink, evidenced in the market’s wild swings and panicked sell-offs.

Buffett waits patiently for those over-reactions, then gobbles up underpriced shares when others are fearful.

When deciding on a personal investing strategy, self-examination is a crucial step in deciding how you will proceed.

Tap the ❤ if you learned something. I’ve interviewed a number of top financial thinkers on my podcast. You should listen to the experts to learn more. Don’t take any of this as a specific financial recommendation.

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