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Some money managers have beaten the markets. In fact, beating the market over a year or three years isn't difficult, but few can beat the market over a decade or more. Efficient market supporters argue that some of those who beat the markets, even over a ten-year period, do so because of luck. Consider that if you flip a coin five times, on some occasions, you get five consecutive heads. This coincidence actually happens, on average, once every 32 times you do five coin-flip sequences because of random luck, not skill. Consistently identifying in advance which sequence gives you five consecutive heads is not possible.
Strict believers in the efficient market hypothesis say that it's equally impossible to identify the best money managers in advance. Some money managers, such as those who manage mutual funds, possess publicly available track records. Inspecting those track records and doing other common-sense things, such as investing in funds that minimize your expenses, improves your odds of performing a bit better than the market.
Various investment markets differ in how efficient (that is, that the current price of an investment accurately reflects its true value) they are. Although the stock market is reasonably efficient, many consider the bond market even more efficient. The real estate market is less efficient because properties are unique and sometimes less competition and access to information exist. If you can locate a seller who really needs to sell, you may be able to buy property at a discount from what it's really worth. In contrast, if several people fall in love with a property, a bidding war may ensue and the ultimate victor may pay far more than the market value. Small business is also less efficient. Entrepreneurs with innovative ideas and approaches can earn enormous returns.
Part II: Stocks, Bonds, Bay Street, and Wall Street
Specialists execute trades and make big bucks
Although not officially recognized until the Exchange Act passed in the U.S. afterthe Great
Depression, the specialist system oftrading actually began on the New York Stock Exchange around 1865. A specialist (and his or her firm) is a memberofthe exchange and isthe focal point for trading a listed stock. Getting into this specialist's club requires a lot of money, in order to maintain a market in the securities the specialist is responsible for, and selection by the board of governors of the Exchange.
In most stocks, all trading centres around one specialist (several dozen stocks have two specialists). Specialists must maintain a continuous and stable market in the stocks thatthey handle. Specialists perform numerous functions that earn them megabucks. Specialists match up buy and sell orders to execute the trades that brokers place with them — in other words, they too earn a commission orcuton deals.
Specialists can also trade and hold stock positions in their own accounts. A few people and studies have raised questions about the specialist's potential for conflicts of interest in their work because oftheircapacityto maintaintheir own accounts. Specialists can onlytrade fortheir own accounts aftertheyVe fulfilled all the orders from other investors. Thus, specialists can only step in and buy or sell from their own accounts when an excess of sell or buy orders exists.
Althoughyou may expectspecialiststo be decimated because they may buy and sell when
others don't want them to, you'd be wrong. Although specialist firms aren't required to disclose the profits from their own investment accounts, several studies during periods ofhigh market volatility demonstrate that specialists profit handsomely. For example, when President John F. Kennedy was assassinated on November 22,1963, the stock market plunged. The next day, the market opened sharply higher. A U.S. government investigation found that specialists didn't step in to buy shares during the heavy selling on the 22nd until after they allowed prices to plummet, instead of attempting to support [Mices
Prior 45 percent U.S. stock market in 1973 and 1974,specialists made near-record use of a trading technique known as short-selling. Short-selling enables an investor to profit by first selling the stock and later rebuying it when stock prices go down
Economist Milton Friedman said the following in Newsweekin 1968; "Private monopolies seldom last long unless they can get governmental assistance in preserving their monopolistic position. In the stock market, the SEC both provides that assistance and shelters the industry from antitrust action." What Friedman said was more true then than today — retail brokerage firms in those days all charged the same commissions to the investing public. Butthe specialist system is still in place today, and recent data shows that specialists still make piles of money.
One of the keys to building wealth is to focus your time and investment strategies in a way that reflects the realities of the investment marketplaces that you invest in. If you desire to earn superior returns, you're better off trying to invest on your own in less-efficient markets like real estate and small business. On the other hand, trying to beat the market averages and the best