Author: Burton G. Malkiel
Date Published: 2016
A Random Walk Down Wall Street – Author Background
Burton Gordon Malkiel was born on 28 August, 1932. He is an American economist and writer, most famous for his classic finance book A Random Walk Down Wall Street (first published 1973, and now in its 12th edition as of 2019). He is a leading proponent of the efficient-market hypothesis, which contends that prices of publicly traded assets reflect all publicly available information, although he has also pointed out that some markets are evidently inefficient, exhibiting signs of non-random walk.
Malkiel is a professor of economics at Princeton University, and is a two-time chairman of the economics department there. He also spent 28 years as a director of the Vanguard Group.
Malkiel in general supports buying and holding index funds as the most effective portfolio-management strategy but does think it is viable to actively manage “around the edges” of such a portfolio.
A Random Walk Down Wall Street – Book Summary
The following is a summary of the book chapters and some key words/notes extracted directly from the text. They are the words of Burton Malkiel.
Part 1 – Stocks and their Value
Chapter 1 – FIRM FOUNDATIONS AND CASTLES IN THE AIR
- You can do as well as the experts—perhaps even better
- A random walk is one in which future steps or directions cannot be predicted on the basis of past history. When the term is applied to the stock market, it means that short-run changes in stock prices are unpredictable
- I view investing as a method of purchasing assets to gain profit in the form of reasonably predictable income (dividends, interest, or rentals) and/or appreciation over the long term
Chapter 2 – THE MADNESS OF CROWDS
- The psychology of speculation is a veritable theater of the absurd
- Unsustainable prices may persist for years, but eventually they reverse themselves
- The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze. It is not hard to make money in the market. What is hard to avoid is the alluring temptation to throw your money away on short, get rich-quick speculative binges
Chapter 3 – SPECULATIVE BUBBLES FROM THE SIXTIES INTO THE NINETIES
- The lessons of market history are clear. Styles and fashions in investors’ evaluations of securities can and often do play a critical role in the pricing of securities. The stock market at times conforms well to the castle-in-the-air theory. For this reason, the game of investing can be extremely dangerous
Chapter 4 – THE EXPLOSIVE BUBBLES OF THE EARLY 2000s
- The internet bubble of 2000 was a stock market bubble caused by excessive speculation in Internet-related companies in the late 1990’s. Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index rose 400%, only to fall 78% from its peak by October 2002, giving up all its gains during the bubble
- Markets are not always or even usually correct. But NO ONE PERSON OR INSTITUTION CONSISTENTLY KNOWS MORE THAN THE MARKET
Part 2 – How The Pros Play The Biggest Game In Town
Chapter 5 – TECHNICAL AND FUNDAMENTAL ANALYSIS
- The first principle of technical analysis is that all information about earnings, dividends, and the future performance of a company is automatically reflected in the company’s past market prices
- A stock that is rising tends to keep on rising, whereas a stock at rest tends to remain at rest
- The fundamentalist’s primary concern is with what a stock is really worth
- Many analysts use a combination of techniques to judge whether individual stocks are attractive for purchase
- Rules to consider include:
- Rule 1: Buy only companies that are expected to have above-average earnings growth for five or more years
- Rule 2: Never pay more for a stock than its firm foundation of value
- Rule3: Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air
Chapter 6: TECHNICAL ANALYSIS AND THE RANDOM-WALK THEORY
- The fundamentalist’s primary concern is with what a stock is really worth
- Technical methods cannot be used to make useful investment strategies. This is the fundamental conclusion of the random walk theory
- Any regularity in the stock market that can be discovered and acted upon profitably is bound to destroy itself. This is the fundamental reason why I am convinced that no one will be successful in using technical methods to get above-average returns in the stock market.
Chapter 7: HOW GOOD IS FUNDAMENTAL ANALYSIS? THE EFFICIENT-MARKET HYPOTHESIS
- The evidence in favor of index investing grows stronger over time.
- When one looks at a five-year period, over two-thirds of active managers are outperformed by their benchmark indexes.
- Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns.
Part 3 – The New Investment Technology
Chapter 8 – A NEW WALKING SHOE: MODERN PORTFOLIO THEORY
- Despite all the critics, traditional index funds remain the undisputed champions in taking the most profitable stroll through the market
- Portfolio theory begins with the premise that all investors are like my wife—they are risk-averse. They want high returns and guaranteed outcomes. The theory tells investors how to combine stocks in their portfolios to give them the least risk possible, consistent with the return they seek. It also gives a rigorous mathematical justification for the time-honored investment maxim that diversification is a sensible strategy for individuals who like to reduce their risks
Chapter 9 – REAPING REWARD BY INCREASING RISK
- Systematic risk, also called market risk, captures the reaction of individual stocks (or portfolios) to general market swings
- Unsystematic risk is the variability in stock prices (and, therefore, in returns from stocks) that results from factors peculiar to an individual company
- It appears that the only way to obtain higher long-run investment returns is to accept greater risk
Chapter 10 – BEHAVIORAL FINANCE
- Here are the most important insights from behavioral finance.
- Avoid Herd Behavior
- Avoid overtrading
- If You Do Trade: Sell Losers, Not Winners
Chapter 11 – IS “SMART BETA” REALLY SMART?
- All “smart beta” strategies represent active management rather than indexing
- “Smart beta” strategies rely on a type of active management. They do not try to select individual stocks but rather tilt the portfolio toward various characteristics that have historically appeared to generate larger-than-market returns. In their favor, the “smart beta” portfolios provide these factor tilts at expense ratios that are lower than those charged by traditional active managers
- There is a remarkably large body of evidence suggesting that professional investment managers are not able to outperform index funds that simply buy and hold the broad stock-market portfolio
- The core of every portfolio should consist of low-cost, tax-efficient, broad-based index funds
Part 4 – A Practical Guide for Random Walkers and other Investors
Chapter 12 – A FITNESS MANUAL FOR RANDOM WALKERS AND OTHER INVESTORS
- The single most important thing you can do to achieve financial security is to begin a regular savings program and to start it as early as possible. The only reliable route to a comfortable retirement is to build up a nest egg slowly and steadily
- Every family needs a cash reserve as well as adequate insurance to cope with the catastrophes of life
- Most people need insurance. Those with family obligations are downright negligent if they don’t purchase insurance
- Take advantage of every opportunity to make your savings tax-deductible and to let your savings and investments grow tax-free
- A good house on good land keeps its value no matter what happens to money. As long as the world’s population continues to grow, the demand for real estate will be among the most dependable inflation hedges available
- There could be a modest role for gold in your portfolio
- I would also steer clear of hedge-fund and private-equity and venture-capital funds
- Diversification reduces risk and makes it far more likely that you will achieve the kind of good average long-run return that meets your investment objective
Chapter 13 – HANDICAPPING THE FINANCIAL RACE: A PRIMER IN UNDERSTANDING AND PROJECTING RETURNS FROM STOCKS AND BONDS
- Very long-run returns from common stocks are driven by two critical factors: the dividend yield at the time of purchase, and the future growth rate of earnings and dividends
- Long-run equity return = Initial dividend yield + growth rate
Chapter 14 – A LIFE-CYCLE GUIDE TO INVESTING
- Some key asset allocation principles:
- History shows that risk and return are related.
- The risk of investing in common stocks and bonds depends on the length of time the investments are held. The longer an investor’s holding period, the lower the likely variation in the asset’s return.
- Dollar-cost averaging can be a useful, though controversial, technique to reduce the risk of stock and bond investment.
- Rebalancing can reduce risk and, in some circumstances, increase investment returns.
- You must distinguish between your attitude toward and your capacity for risk. The risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income
- Three guidelines to tailoring a life-cycle investment plan:
- Specific Needs Require Dedicated Specific Assets
- Recognize Your Tolerance for Risk
- Persistent saving in regular amounts, no matter how small, pays off
- In the Life-Cycle Investment Guide section, a number of different portfolios are suggested, based on one’s age…for example for this in the mid 50’s, the following is suggested:
- Cash 5%
- Bonds 27.5%
- Stocks 55%
- REITS (real estate) 12.5%
- Under the “4 percent solution,” you should spend no more than 4 percent of the total value of your nest egg annually. At that rate the odds are good that you will not run out of money even if you live to a hundred.
Chapter 15 – THREE GIANT STEPS DOWN WALL STREET
- THE NO-BRAINER STEP: INVESTING IN INDEX FUNDS
- The Standard & Poor’s 500-Stock Index, a composite that represents about three-quarters of the value of all U.S.-traded common stocks, beats most of the experts over the long pull. Buying a portfolio of all companies in this index would be an easy way to own stocks.
- The Vanguard 500 Index Trust purchased the 500 stocks of the S&P 500 in the same proportions as their weight in the index.
- I believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is one of the broader indexes such as the Russell 3000, the Wilshire 5000 Total Market Index, the CRSP Index, or the MSCI U.S. Broad Market Index—not the S&P 500.
- I favor investing in an index that contains a much broader representation of U.S. companies, including large numbers of the small dynamic companies that are likely to be in early stages of their growth cycles
- One of the biggest mistakes that investors make is to fail to obtain sufficient international diversification
- I suggest that a substantial part of every portfolio be invested in emerging markets
- A SPECIFIC INDEX-FUND PORTFOLIO FOR AGING BABY BOOMERS
- Cash (5%)
- Fidelity Money Market Fund (FXLXX)
- or Vanguard Prime Money Market Fund (VMMXX)
- Bonds and Bond Substitutes (27½%)
- 7½% U.S. Vanguard Intermediate Term Bond (VICSX)
- or iShares Corporate Bond ETF (LQD)
- 7½% Vanguard Emerging Market Government Bond Fund (VGAVX)
- 12½% Wisdom Tree Dividend Growth Fund (DGRW)
- or Vanguard Dividend Growth Fund (VDIGX)
- Real Estate Equities (12½%)
- Vanguard REIT Index Fund (VGSIX)
- or Fidelity Spartan REIT Index Fund (FRXIX)
- Stocks (55%)
- 27% U.S. Stocks
- Schwab Total Stock Market Index Fund (SWTSX)
- or Vanguard Total Stock Market Index Fund (VTSMX)
- 14% Developed International Markets
- Schwab International Index Fund (SWISX)
- or Vanguard International Index Fund (VTMGX)
- 14% Emerging International Markets
- Vanguard Emerging Markets Index Fund (VEIEX)
- or Fidelity Spartan Emerging Markets Index Fund (FFMAX)
- THE DO-IT-YOURSELF STEP: POTENTIALLY USEFUL STOCK-PICKING RULES
- Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years
- Rule 2: Never pay more for a stock than can reasonably be justified by a firm foundation of value
- Rule 3: It helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air
- Rule 4: Trade as little as possible
- If you do want to pick stocks yourself, I strongly suggest a mixed strategy: Index the core of your portfolio, and try the stock-picking game for the money you can afford to put at somewhat greater risk.
- I believe that investors need to put more China into their portfolios than is available in general world or emerging-market index funds. Three of them that trade on the New York Stock Exchange are YAO (an index fund representing all Chinese companies available to international investors), HAO (a small-capitalization index fund that contains more entrepreneurial companies and ones with less government ownership), and TAO (a Chinese real estate fund).
- THE SUBSTITUTE-PLAYER STEP: HIRING A PROFESSIONAL WALL STREET WALKER
- Instead of trying to pick the individual winners (stocks), pick the best coaches (investment managers). These “coaches” come in the form of active mutual-fund managers, and there are thousands of them for you to pick from
- Morningstar is one of the most comprehensive sources of mutual fund information an investor can find
- I suggest that investors never buy actively managed funds with expense ratios above 50 basis points (½ of 1 percent) and with turnover of more than 50 percent
- 27% U.S. Stocks
A Random Walk Down Wall Street – CLOSING THOUGHTS
I enjoyed the read however, it did come across somewhat as a textbook and it didn’t have the humour and nice succinct summaries that you would find say in a Peter Lynch book. When I read a book, particularly on investing, I quickly look for the key summary points and if there is some obvious realism and humour present, then that is indeed a bargain.
If I understand the key essence of this book, it is that Burton supports buying and holding low cost, diversified (US and International) index funds and defaulting to time in the market, not trying to time the market.
Giving Burton the final say, “If you will follow the simple rules and timeless lessons espoused in this book, you are likely to do just fine, even during the toughest of times”.
If you enjoyed this book review, you will enjoy my review of the classic, “One Up On Wall Street“.
Read, learn, enjoy, be persistent and most importantly, take action!