What is the Efficient Market Hypothesis (EMH) and its implications for active vs passive investing?

• A. EMH suggests prices reflect all available information; prices reflect information; consistent active outperformance unlikely after costs, supporting passive investing.
• B. EMH asserts markets are always overvalued.
• C. EMH states only insiders can achieve excess returns.
• D. EMH says active management always beats index funds.

Answer: (A)

The main idea behind the Efficient Market Hypothesis is that prices already reflect all available information, and new information is incorporated quickly as it arrives. If prices already reflect what’s known, then consistently picking stocks or timing the market to earn excess returns after costs becomes unlikely. That’s why a passive investing approach—buying a broad market index and holding it—often delivers similar, or better, net returns over time than most active strategies, once fees and taxes are considered.

Different forms of EMH emphasize how much information is reflected: public information, all public and private information, etc. Yet in practice, markets aren’t perfectly efficient all the time, so there can be short-lived mispricings; these opportunities don’t reliably persist after costs, which is why passive investing remains appealing for most investors.

The other statements misstate EMH: it doesn’t claim markets are always overvalued, it doesn’t say only insiders can earn excess returns, and it doesn’t assert that active management will always beat index funds.