There are a lot of illusory ideas out there for beating the market. But I do believe there’s at least one way to do so without any special expertise, and that’s to studiously avoid being sucked into the frenzied, speculative bubbles that seem to reliably take hold of a significant fraction of the population.
In an efficient market, one might expect the smart, rational players to correct these bubbles. But once they’ve sold all their own holdings, you’re left with a Winner’s Curse [1] dynamic where the most (irrationally) optimistic investors are the ones ultimately setting the price. And essentially the only way the rational players can affect things from there is through short-selling, thereby risking running afoul of Keynes’ famous adage about the market remaining irrational for longer than they can remain solvent.
Thus there can fairly regularly arise situations in which somewhat common knowledge has it that some asset is overvalued, without the price of that asset collapsing. Until eventually it does.
It seems to me, then, that it’s not so foolish to attempt to get some of the diversification benefits of an index fund, while avoiding particular components whose valuations seem to defy rationality.
In an efficient market, one might expect the smart, rational players to correct these bubbles. But once they’ve sold all their own holdings, you’re left with a Winner’s Curse [1] dynamic where the most (irrationally) optimistic investors are the ones ultimately setting the price. And essentially the only way the rational players can affect things from there is through short-selling, thereby risking running afoul of Keynes’ famous adage about the market remaining irrational for longer than they can remain solvent.
Thus there can fairly regularly arise situations in which somewhat common knowledge has it that some asset is overvalued, without the price of that asset collapsing. Until eventually it does.
It seems to me, then, that it’s not so foolish to attempt to get some of the diversification benefits of an index fund, while avoiding particular components whose valuations seem to defy rationality.
[1] https://en.wikipedia.org/wiki/Winner's_curse