One Easy Way to Improve Your Investing Strategy: Rethink the Idea of Asset Markets

Forget everything you know about markets for a minute.

In about 45 seconds, I will ask you to clear your mind and erase your understanding of the stock market (temporarily, of course).

First, we need to briskly slog through two economic theories. Bear with me.

The efficient market theory argues that asset prices reflect all available information and trade at their fair values. In turn, it should be impossible to beat the market — because you shouldn’t be able to find undervalued assets or sell assets at inflated prices.

Based on this theory, it doesn’t make sense to fundamentally or technically analyze stocks or the broader market. Why bother if you can’t “win” anyway?

As you’d expect, it’s a controversial theory.

The inefficient market theory argues the opposite: asset prices do not reflect all public information. Therefore, prices don’t reflect fair values. So, technical analysis and fundamental analysis are worthwhile since investors can find bargains and outgain the market.

There’s plenty of empirical evidence that supports the latter theory — people beat the stock market every year. Still, I want to take this a step further. Let’s strip all the jargon and numbers from the concept of an asset marketplace.

Erase your image of the stock market — or any market for that matter (crypto market, NFT market, real estate, etc.). Pull back the ticker symbols, industries, metrics, earnings, and, yes, even memes. Delete the coins, white papers, value propositions, blockchains, and, again, the memes.

What do you have? People.

More specifically, people buying, holding, and selling things. Based on what? Unique circumstances and values.

Your finances are different from mine, just as mine are different from anyone else’s. We have unique risk preferences, investment goals, personal needs, thoughts, biases, fears, emotions — all of which influence not only our investment decisions but also how we individually value certain assets.

We also have unique backgrounds and experiences. Someone who lost half of their wealth during the great recession is less inclined to stake their financial stability in Bitcoin. Someone who started investing for the very first time in March 2020 — and has achieved gargantuan returns — is more likely to have inflated confidence and speculate on cryptos.

Our personal values also influence how we evaluate tradable assets. It’s the same premise behind an NFT selling for $69 million, or an Italian artist’s “invisible sculpture” (i.e., nothing) selling for $18,000. But no one’s buying my nephew’s art class painting.

Toss in our emotional behaviors and biases, and it’s no wonder that markets are unpredictable. We make rash decisions. We listen too intently to good news and ignore bad news. We follow crowds. We get FOMO. We panic. We splurge.

Altogether, these things make “value” really hard to pin down. What makes Tesla worth $1,000+ a share and Ford worth $15? (If you want to be a stickler and look at them from a market cap perspective, replace the comparison with $1 trillion and $60 billion.)

More people believe in the former’s future— they ascribe a higher value to Tesla.

Ultimately, value boils down to someone’s personal values, circumstances, and willingness to outbid the next buyer. In that sense, “beating the market” is akin to choosing assets that people will assign higher and higher values to over time.

How to use this perspective to enhance your investing strategy

Before anyone jumps to conclusions, I’m not suggesting that research and asset evaluation are wastes of time. As a long-term investor, I will always advocate for due diligence and fundamental analysis.

Even though people are the underlying contributor to the market volatility and value discrepancies, we can’t ignore the fact that people can act rationally too. We’re emotional, but that doesn’t mean we lack common sense.

Instead, I think it helps to keep this simple concept in mind: people ultimately decide value, not metrics. A stock could trade at a price-to-earnings ratio of 3 and seem heavily undervalued, but that doesn’t mean people will act on it. A cryptocurrency like Bitcoin can surpass $100,000 — and go even higher — so long as someone’s willing to buy it at that price.

So, to enhance your strategy, use this down-to-earth view of markets as a reality check — if a particular investment checks all of your boxes, ask yourself, “Why will people value this asset more in the future than what I’m purchasing it for today?”

If you can answer this question confidently and logically, then it passes the reality test.

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