I was wondering if you could disseminate some information on the Efficient Market Theory. Is indexing, with its lower expense ratios and lack of the human factor (fund manager), a better way to use mutual funds effectively for the long term? Considering how many managers with their higher fees underperform the market as a whole, I'm beginning to wonder. -- Fred Greenfield


You have entered one of the great academic debates.

The classic version of the Efficient Market Theory, or EMT, states that all information is factored fully and instantaneously into market prices. Under this interpretation, it would be impossible to beat the market and pointless to try to identify undervalued stocks or to predict market movements.

This version "has basically been discredited," says Andrew Lo, a professor at the

MIT Sloan School of Management

and director of the

Laboratory for Financial Engineering

. People no longer believe this occurrence is immediate. Thus, it is possible, though not easy, to outperform the market.

The contemporary version of the EMT acknowledges that "there are lots of smart people working to make money for themselves and their clients," says Lo, co-author of the book

A Non-Random Walk Down Wall Street .

The newer version of the Efficient Market Theory recognizes that investing is a "highly competitive arena in which you cannot expect to earn superior returns unless you put in superior effort," adds Lo. "It says that it is very hard to make money, and you don't get something for nothing."

"What it doesn't say is that indexing is the only way to go," Lo adds. But "like any other kind of shopping, it is hard to find value unless you spend a lot of time doing it."

Lo explains EMT in simple terms that anyone could understand. That is not always the case when trying to research this subject.

You can find myriad academic papers on the subject all over the Internet, but I doubt reading them all would answer your question. (Reading them wouldn't be much fun for the average investor, either.) And the debates and discussions over this theory certainly will continue.

Like many investors, you seem to be dismayed with the fees you have to pay active managers, many of whom don't beat the market. In 1998, 17.2% of actively managed general equity funds (excluding index and sector funds) outpaced the

S&P 500

, according to



The Efficient Market Theory won't tell you whether to buy an actively managed fund or an index fund.

It isn't futile to invest in actively managed funds. But if you do, your selection process would certainly require time, effort, creativity, skill and luck.

Frankly, if you spend more time on your research, you may have a better chance of finding an actively managed fund that can beat the market.

There may be a lot of people who disagree with me, but I can take it.

Email me at

fundforum@thestreet.com, and please include your full name.

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