[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

well as—no better and no worse than—the S&P 500 index, after a small
charge for managing the fund is taken into account.
Because the index funds have low expenses, particularly in comparison
with funds that are trying to outguess the market, they yield higher average
returns to their investors than other funds with comparable risk.
3. Look at all the risks you face, not just those in your financial portfolio. Many
people may be far less diversified than they believe. For example, consider
someone who works for the one big company in town. She owns a house, has a
good job, and has stock in the company, money in the bank, and a pension
plan. But if that single company goes broke, she will lose her job, the value of
her stock will fall, the price of her house is likely to decline as the local economy
suffers, and even the pension plan may not pay as much as expected.
4. Think twice before you think you can beat the market! Efficient market theory
delivers an important message to the personal investor. If an investment
adviser tells you of an opportunity that beats the others on all counts, don’t
believe him. The bond that will produce a higher than average return carries
with it more risk. The bank account that has a higher interest rate has less
liquidity. The dream house at an unbelievable price probably has a leaky roof.
The tax-favored bond will have a lower return—and so on. Efficient market
theory, as we have seen, says that information about these characteristics is
built into the price of assets, and hence built into the returns. Basically,
investors can adjust the return to their portfolios only by adjusting the risk
they face. Burton Malkiel, author of the best-selling book A Random Walk
Down Wall Street, applies this theory to personal investment: “Every investor
must decide the trade-off he or she is willing to make between eating well and
sleeping well. The decision is up to you. High investment returns can be
achieved only at the cost of substantial risk taking.” 4
4 7th ed. (New York: Norton, 1999), p. 281.
886 ∂ CHAPTER 39 A STUDENT’S GUIDE TO INVESTING