Markets Work...Here's How

Updated: Mar 22, 2019

Many of the greatest advancements in finance have come from academia.

The academic community offers a wealth of insight into how markets work and the sources of expected returns. This timeline offers some of the high points in the evolution of modern finance.

Investment planning has evolved over time from basic stock picking to portfolio construction grounded in academic research. This research has also helped advisors like us obtain a better understanding of risks and sources of returns so we can do a better job customizing portfolios to client needs.

One driving principle is that “markets work”—that is, market prices reflect all available information and expectations of the future. This is known as market efficiency. The forces of supply and demand are constantly at work in the financial markets, and the intense competition pushes stock and bond prices toward their actual value.

People trust markets every day. For example, when shopping, you probably don’t question whether the price for an item is “right” or “wrong.” You simply assume the price reflects local market conditions. You might decide the price is too high and choose not to buy—and if enough people don’t buy the item, the price drops. This is how a market works. Yet, many people’s perception of market pricing breaks down when they invest because they assume that the price of a stock or bond may not be right. They are conditioned to view some stocks as being “overvalued” or “undervalued.”

In reality, the financial markets work much like any other market, with information and opinions affecting the price of a stock or bond. That price reflects the aggregate view of what the investment is worth at that moment in time. The forces of supply and demand push prices toward market equilibrium—and these forces are at work in the financial markets.

To learn more on science-based investment strategies, contact Private Wealth Management Group.

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