Learn From the Fama/Shiller "Disagreement"

Much has been written about the significance and irony of both Eugene Fama and Robert Shiller being awarded the Nobel Prize in Economic Sciences. The best source to define their areas of difference is Robert Shiller himself. In an article published in The New York Times, Shiller summarized Fama's efficient-markets theory as asserting that "financial prices efficiently incorporate all available information and are in that sense perfect." In contrast, Shiller believes financial prices are "far from perfect" because they don't take into consideration "the enormous role played in markets by human error, as documented in now-established literature called behavioral finance."

At first blush, proponents of active management might find solace in Shiller's views. A closer analysis indicates such a view would be misplaced.

Shiller agrees that it is exceedingly difficult for the "average amateur investor" to "get rich quickly" by trading on publicly available information. With his personal investments, Shiller avoids excessive trading and has "a high level of skepticism about investing tips."

For most investors, the philosophical disagreement between Fama and Shiller is an academic one of little practical consequence. Shiller's primary quarrel with Fama's views is his concern that fiscal authorities will be influenced by them in setting economic policy.

Shiller even concedes that he can recommend to investors that they consider using passively managed funds run by Dimensional Fund Advisors. Fama is an adviser to Dimensional, which follows many of his investing theories, including his premise that the stock returns of small and value companies may generate higher expected returns over the long term.

Investors should not be distracted by the theoretical differences between the views of Fama and Shiller. Instead, they should focus on factors they can control: diversifying risk; having an investment plan and sticking to it; and structuring a globally diversified portfolio of low-management index funds, preferably tilted toward small and value stocks.

Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.