A recent phone conversation with my four-year-old niece removed all doubt, at least in my mind for that moment. According to her, Santa Claus was busy making his list and checking it twice. Who am I to argue otherwise?

On to the next topic of debate: Are capital markets efficient? Not long ago, I received a call from a Coffeehouse Investor, a retired doctor who continues to embrace life with the wonder of a four-year-old and the wisdom of a sage. She said, “Bill, you’ve got to explain the basics. You’ve got to discuss efficient markets.”

It is time to get back to the basics of investing. Are capital markets efficient? Your answer is likely to have a major impact on how you build and maintain your portfolio. The Santa Claus debate might have stirred up some light-hearted opinions around the holiday dinner table, but it’s the efficient markets debate that stirs up some big-time controversy within the academic and financial community. Which side of the table are you on?

We deal with market efficiencies every day of our lives. How far are out of your way will you go to save 20 cents on a gallon of gas? Millions of motorists vote this decision every day, and as a result, the price of gasoline stays relatively uniform within a neighborhood radius.

When it comes to investing in the stock market, do these same efficiencies apply?

Wall Street suggests that anyone who spends enough time analyzing financial reports, interviewing company presidents, talking to research analysts and reading The Wall Street Journal, can pick enough good companies and avoid enough bad companies to outperform the stock market average, which is made up of all the good companies and all the bad companies, combined.

It sounds good in theory, and it certainly captures that part of our investing psyche that wants to own fast-growing companies which are making bundles of money with no downturn in sight. Unfortunately, there is one small catch to this investment approach; there are millions of investors who are thinking the same as you.

As a result, the actions of these millions of investors have caused the price of fast-growing companies (growth stocks) to be bid up to a level that approximates the same price paid for earnings of slow-growing companies (value stocks). In the short run, the voting by millions of investors can cause these valuations to be irrational and unexplainable. Not so, in the long run.

This is stock market efficiency in action, or so the argument goes. How does this theory play itself out in real life? Is it possible to pick enough good companies and avoid enough bad companies and outperform the stock market average — in the long run?

Checking the performance records of actively managed mutual funds during the fifteen year period ending 1999, Morningstar’s Principia program revealed that only 97 of 336 equity mutual funds, less than 30 percent, outperformed the Wilshire 5000 stock index, the index that best represents the entire stock market.

What do these statistics show? First, the stock market is relatively efficient over the long haul, as indicated by the small number of “professional” stock pickers that bested the market’s return.

Second, these numbers show that although it is possible to beat the market, as indicated by the few mutual funds that accomplished just that, the probability of choosing the top funds in the future isn’t great, especially when exhaustive research has shown the randomness of future top performers.

Do these numbers prove that the stock market is efficient? The debate will never end, especially for amateur investors who are more intent on quick riches than building long-term wealth. For these investors who attempt to take advantage of market inefficiencies and beat the market over the long haul, the odds imply it is a gamble, not an investment.

Do-it-yourself stock pickers will forever point to Wall Street’s anemic track record as proof enough that they can do better on their own. The unfortunate reality is that if they were to take the time to monitor their long-term performance, these investors would realize that market efficiencies have to be dealt with by everyone, not just the mutual funds which are required to post performance records.

The tragedy of the efficient markets debate is not that most actively managed mutual funds under-perform the market’s long term return, but that the average stock picker and mutual fund investor switches investments at an alarmingly high rate, capturing only a fraction of the market’s long term return in the process. While we’re in the midst of the debate, how has your equity portfolio stacked up to the efficiencies of the marketplace over the last ten years?

The Coffeehouse philosophy of capturing the stock market’s entire long-term return is a recognition that capital markets are relatively efficient, and any attempt to beat the average is likely to be met with disastrous results. Wall Street will tell you otherwise, and the debate will never subside. For Coffeehouse Investors, it isn’t a debate — it is the basic philosophy upon which portfolios are built.

(Editor’s Note: Bill Schultheis is nationally known as a stock market analyst. His Coffeehouse Investor column appears in numerous publications throughout the country. He may be reached at william@seanet.com.).