Final answer:
The best strategy for a small investor according to the efficient-market hypothesis is to invest in mutual funds, particularly an index fund, as it offers diversification and a stable return that reflects overall market performance, without attempting to outperform the market.
Step-by-step explanation:
According to proponents of the efficient-market hypothesis, the best strategy for a small investor with a portfolio worth $40,000 is probably to invest money at risk in mutual funds, notably in an index fund. The logic behind this recommendation is that the efficient-market hypothesis suggests that it is difficult to consistently outperform the market through individual stock selection or timing due to the market's ability to reflect all available information in stock prices efficiently. Therefore, for the average investor, attempting to perform fundamental analysis or exploit market anomalies is less likely to yield better results than professional investors.
Furthermore, historical data indicates that a substantial proportion of mutual funds that attempt to beat the market actually perform worse than the market average. Hence, a strategy of investing in an index fund, which aims to replicate the overall behavior of the stock market, offers diversification and reduces risk without the expectation of outperforming the market. Such funds hold a mix of securities that represent the market, which tends to provide a stable average return over time.