Final answer:
Should all investors adopt a passive investment strategy, it could challenge the market's ability to self-correct and align stock prices with their true value, potentially affecting market efficiency.
Step-by-step explanation:
If all investors attempted to follow a passive strategy, relying on market averages rather than attempting to outguess the market, the dynamics of market efficiency would undergo significant changes. In the context of the efficient market hypothesis, which assumes that stock prices incorporate all information and therefore always reflect the true value of a stock, the random walk theory proposes that stock prices evolve according to unpredictable paths, making it nearly impossible to consistently outperform the market average.
Although some investment advisers may succeed in beating the market in the short term, statistically, the majority do not. The historical performance of mutual funds reveals that a substantial portion underperforms compared to the market average. This underperformance highlights the difficulty and inherent risks involved in selecting stocks that will provide returns significantly above the market average.
If all investors embraced passive strategies, it's likely that active stock picking would decline, potentially reducing the pressure on prices to reflect the true value based on new information (as fewer individuals would be acting on specific information in the hope of achieving above-average returns). This could impact the market's self-correcting mechanism to align prices with actual value. Market efficiency could be compromised because the mechanism by which new information is incorporated into stock prices—the active trading based on that information—would be diminished.