the EMH doesn’t mean that no-one does any research, it’s just that for any given stock the reasearch has already been done by someone so that the price of the stock reflects its ‘true’ valuation. To be more technical, what the EMH says is that there are no unexploited arbitrage opportunities. Modern matched-bargaining systems have greatly increased market efficiency.

Index funds are essentailly decoupled from the EMH. All the figures that go into your fund manager’s spreadsheet are derived from the index (one of the most important figures in portfolio managment, for example, is the correlation between the return on a stock and the return on the index -this is called beta). To all intents and purposes, the index is the market. If a security conforms closely to the EMH, then a fortiori the index does.

Investing in small caps (OTCBB, Pink Sheets, etc) does give you a higher potential return. But your risk is concomitantly higher. Your investment strategy should be to pick a portfolio of stocks that puts you at a distance on the critical line away from the Minimum Variance Portfolio (for some given rate of return on the efficient frontier) that you are comfortable with. If that’s gibberish to you, then buy DJIA, QQQ or FTSE100 and hit the textbooks. You can lose your shirt here if you’re not careful. The fund guys can do a lot of things that are not available to the ordinary private investor (try getting a margin-enabled account, for example!). In my experience, ‘picking winners’ is a mug’s game without inside knowledge, and that’s illegal.

1. If you want the return of the personal investor (whether supposing he’s less rational and will allow you to snaffle his funds more readily or otherwise) then Cargo Cult economics is not the influence to worry about. Institutional investing is buttressed on either side by the tax system and an insurance culture.

2. Institutions are not necessarily more rational than individuals. Often they are less, because it is easier to go mad with other people’s money than your own. (Certainly they too are strongly subject to confirmation bias.) It’s just they have different sorts of irrationality, different tastes in financial porn.

The professional managers, as you correctly pointed out, do handle the money in most businesses. My point was that they make their investments on the basis of risk/reward ratios.

Because calculations of those ratios ultimately depend on predictions of various ingredient factors that have to be made based on experience, they are reliable for low risk/low reward/high experience situations and unreliable for high risk/high reward/low experience ones. Although their work seems very objective and analytical, it can’t get away from the experience factor. As a result, they avoid the investments that they cannot evaluate reliably.

The problem is that occasional high risk/high reward successes are necessary to keep the supply of low risk/low reward investments from being exhausted. This is certainly true in my field where the offset development well prospects wouldn’t be there if someone hadn’t drilled the wildcat which discovered the oilfield sometime in the past. I suspect that this is true in other businesses too. Hollywood has been afflicted by sequels and remakes for a while now. Even as you read this, various ripoffs of the Lord of the Rings are being shown to the professional managers in that business. If you are sick of Rocky XXII type movies, be grateful that there is a New Zealand!

To horribly mix metaphors: our economy, perhaps even our civilization, needs sacrificial lambs who enjoy financial pornography. These may be independent oilmen or garage nanotechnologists. Most of them will fail and lose their investments. That is to be expected for bad investments with poorly quantified risks. A few will succeed and keep the rest of the economy going. That, not the potential profit, is why speculation in ‘bad’ investments is a good thing.

1) It would seem that smaller investors like myself would be better off buying small cap stocks because they would be less subject to EMH?

2) How or why do large investment entities do research if, as you wrote, “researching isn’t going to be helpful”?

3) How, if at all, does EMH affect index investors? I can go either way on this when I think about it; do the proponents of EMH have anything to say about this?

“Weak”-Price and volume data already factored into price, making technical analysis worthless (tested to be true-various technical schemes don’t make money once trading commissions are factored in)

“Semi-strong”-Accounting data and other public news about company already factored into price, making fundamental analysis worthless (tends to be true; market tends towards semi-strong efficiency).

“Strong”-All information is already factored into the price. (Not quite true-otherwise insider trading would be a non-issue; ask Martha Stewart).

The bigger a stock is, the more likely the semi-strong form will hold.

Which leads me to the second reason, loss of freedom. The greater the freedom someone has, the more opportunity that person has. That same person also had increased risk. I am free to win or lose, succeed or fail. Far too easily people have given up their freedom to cut their risk, most not recognizing that they have also cut their opportunity. We need more Ben Franklins in this world, men with the strength to say:”People who are willing to give up freedom for the sake of short term security, deserve neither freedom nor security”.

All I’m saying is that I don’t want them to use better principles or be better off. I want them to be as irrational and superficial as possible so I can be better off.

I absolutely depend on people who laugh at how simple the idea of “buy low, sell high” seems.

I don’t want boatloads of smart investors, I want boatloads of dumb investors. That’s how I make money.

I used to think that splits were great, and then I figured out that having two 10s instead of a 20 is irrelevant and so what’s the point? But finally I realized that most people like splits and they would rather buy two 10s (perhaps one at a time) instead of a 20. And so, if I own a stock, I like splits because of the effect they have on others.

To quote the cop in ‘the Limey’: “The only thing I don’t understand, is every m*****-****ing” word you said.”

There’s just not anything risqué or taboo. To qualify as financial porn there should be remorseless descriptions of illicit dealings to pump a portfolio and how the wife is unaware of all those night deposits…