on July 14, 2004
In a nutshell Malkiel's advice is to own your own home, buy no-load index funds (equities and bonds), buy international index funds, and mix your investments according to your age. You should also have medical and plain term life insurance, and cash on hand for a few months in case of an emergency. This book is a complete course in how to manage your money effectively, whether you're a millionaire or a low-income earner. It also gently but firmly chastises proponents of get-rich-quick schemes such as day traders.
First, the book explains what is financial risk, and points out that everything is risky, even insured savings accounts since inflation can destroy the value of cash. Malkiel describes just how risky various investments are, and how the risk is one investment is often offset by the risk in another. Second, Malkiel describes a variety of specific investments (e.g. no load index funds, your own home, individual stocks) and suggests how individual investors should mix them, depending on their personal circumstances. For instance, an ambitious young woman in her twenties can consider aggressive high-risk high-growth funds. If they boom, she's rich, if they bust she's young enough to recover her losses through income. This would not be true of a middle-aged couple about to pay for their children's college years.
"A Random Walk Down Wall Street" should be in every family's library.
on January 31, 2005
Mr. Malkiel provides an outstanding all-in-one stock book for the educated but non-technical investor. He includes overviews of the financial, economic and psychological foundations for stock markets, as well as entertaining summaries of the history of stock markets in the world and in the U.S. Mr. Malkiel takes a sensible, long-term approach to investing with stocks and bonds, at the same time pouring cold water on various market theories. He approvingly quotes the phrase "the stock market is like a casino in which the odds are rigged in favor of the player" which is probably the best summing-up I've ever encountered when thinking about stocks. Some of his more salient and direct advice includes these gems:
* "A simple 'buy-and-hold' strategy typically makes as much or more money than technical strategies" (p 151).
* "No technical scheme whatever could work for any length of time and ...even if they did work, the schemes would be bound to destroy themselves" (p 167).
* Regularities in stock market movements are arbitraged away over time; whoever spots such a regularity would not tell everyone else, but instead would keep it to him- or herself to get rich (p 168).
* Many analysts are incompetent or are compromised by institutional conflicts of interest (pp 181, 183).
* "The evidence from several studies is remarkably uniform. Investors have done no better with the average mutual fund than they could have done by purchasing and holding an unmanaged broad stock index" (p 187).
* Don't ignore small cap companies: "smaller firms tend to have higher rates of return" (p 239).
* Investors should look for stocks with relatively low P/E ratios and low values relative to their book values (pp 239, 261).
* The only market-timing strategy that makes any empirical sense is to purchase stocks that have had relatively poor recent performance (p 257).
* The stock market goes through manias but is fundamentally logical (p 258).
* Your tolerance for risk should be judged by how well you can sleep at night with your portfolio (p 280).
* Zero coupon bonds can be a good investment if the tax aspects are adequately addressed (p 299).
* "I recommend low-expense bond index funds" (p 300).
* "I now believe that if an investor is to buy one U.S. index fund, the best general U.S. index to emulate is the broader Wilshire 5,000-Stock Index, not the S&P 500" (p 360).
on May 1, 2003
A Random Walk takes the reader on a path from the point of view of an academic, rather than that of a trader. That is sufficient to make this book different from most other stock market tomes. Malkiel's premise is that neither the the average investor nor the professional trader can expect to perform better that the "market" over any significant period of time. He considers market events to be random, and thus unpredictable. He offers piles of data to support his contentions, and his arguments are compelling.
Yet, those who trade using technical analysis scoff at books such at this, claiming their systems consistently beat the averages. The author points to the fact that most managers of mutual funds, pensions etc. fail to perform better than index funds and Malkiel recommends that public investors place their investment money into broad based index funds. The S&P 500 Index fund is recommended, as it is unrealistic to expect fund managers to perform better.
This classic has been around for 30 years and this revised edition is worth your time, especially if you have never read an earlier edition. Just be aware that many technical traders consider this to be a work of fiction.
on July 18, 2005
Let me start by saying this book is an absolute must-read for anybody interested in the stock market and their potential to succeed in it! With that said, this should NOT be the only book on the subject you read. Written by an academic, Random Walk is highly biased towards the Efficient Market Hypothesis, which although important to be aware of, must be understood in its appropriate context (one of many different models of how the market MIGHT work).
If you do read this book you'll receive a valuable financial history lesson exposing you to many of the financial irrationalities of the past (most recently the dot-com bubble) -- this alone makes the book well worth buying!
You'll also receive an introduction to the various forms (three are presented) of the Efficient Market Hypothesis. Without getting into specifics, the EMH discounts an individual's ability to outperform the market by assuming that all publicly available news/information on a company has already been factored into a stock's price. The implication being that by the time you hear about a company's latest developments it's too late to use this information to your advantage.
Although the EMH is important to be aware of, it's also important to realize that not everybody who's trading stocks subscribes to it or accepts it as part of their trading philosophy. You might consider flipping through The Alchemy of Finance after finishing Random Walk to read the opinion of someone who subscribes to a very different trading philosophy!
Random Walk is one of the "classics" that anybody who is serious about the stock market will have read; however, limiting your financial education to just this book would be a very poor idea!
on September 30, 2004
This is actually three books in one.
The first part is a history of stock market bubbles from the 17th to the 21st century. That, in itself, is enough to make this book invaluable.
The second part is an excellent introduction to different investment and stock valuation methods.
The third part is the author's specific investment advice. It is not, as some reviewers have said, a "buy index funds" approach. It is based on asset allocation between stocks, cash, bonds, and real estate, depending on your age and risk tolerance.
While some people, who I am sure are very successful investors, look down on this "simple" asset allocation advice, in my opinion Malkiel's suggestions are right on the money for over 90% of investors. If you can get rich by investing in the stock market, good for you. This section of the book is about preserving and slowly growing your hard-earned savings, based on the amount of risk that you choose to take.
Bottom line: Read this book. It can save you thousands of dollars in bad investments.
on June 7, 2003
I just finished reading the '95 edition and am looking forward to reading the updated version. I would highly recommend this book to any beginning investor (spare me Suze Orman!), or to experience investors who may have dismissed it based on mainstream media characterizations.
After hearing so much about this book over the years, I was surprised after reading it how misunderstood it is.
As it turns out, Malkeil is a "weak" random walker by his own definition, and sometimes mildly mocks the "strong" random walkers who claim all relevent information is reflected in stock prices at all times. I had always dismissed this book as an absurdity based on the understanding that it espouses the strong approach. It most assuredly does not.
He begins the book talking about historic market bubbles and their eventual collapses as examples of ineffecient markets. At the close he describes his inventments in discounted closed end funds as an example of exploiting a market inefficiency.
His thesis is that inefficiencies and insider information can be exploited, but such opportunities are difficult to identify, may be inaccessible to the average investor, and do not persist. So in the absence of this information, how is one to invest over the long term? Mainstream media latches onto the stock indexing approach as though it was the sole method espoused by the author. Although Malkiel presents a compelling case for indexing, and discredits technical analysis outright, his approach is hardly dogmatic and often nuanced.
Other noteable misunderstandings about this book are too numerous to mention here; often purchased but rarely read it seems.
on June 29, 2005
I really enjoyed this book for 4 reasons:
First, I work in the finance industry and have seen professionals consistently make money. I've also seen my personal account underperform the market. This book helped me reconcile the 2 observations. The main point of the book (in my mind) is that there really are $100 bills lying around. They are pretty obvious when you find them, but they disappear quickly and you can't count on finding them. You need to have "an edge" in finding them. (You have to spot the bill sticking out from under the tire of a truck and happen to have a jack strong enough to lift the truck to get the bill.) Professionals looking at non-standard situations or looking at novel data are able to find them. Moreover, some professionals (not mutual fund managers) have the resources to pick them up. A small investor is not likely to find them, and if they do they probably can't reach them. So, the best thing to do as a small investor is invest in everything, i.e. index.
Second, I like that Malkiel presents arguments for and against different strategies. It helps clarify why people think things work, and why they don't, in fact, work in a measurable way. As he provides evidence that the strategies don't produce superior returns, he also drives home the point that the market is very competitive, and as a small investor you are competing at a serious disadvantage.
Third, the writing style is very easy. I know something of the academic research he refers to, and Malkiel has done a fine job distilling the ideas and presenting them language that is common sense.
Fourth, I loved the stories of the various bubbles. Great reading.
The 1 thing I didn't like so much: Malkiel didn't spend more than a paragraph analyzing hedge fund returns... could be due to lack of data. Anecdotally, hedge funds have produced superior risk adjusted returns. I'd like to hear his thoughts on that.
on June 11, 2003
This is a great book on investment theory. It covers the Efficient Market Theory, Arbitrage Pricing Theory, Capital Asset Pricing Model, Beta, Portfolio Theory. It also explains really well how Wall Street operates and values stock. It explains the two main valuation tools used by the pros: fundamental analysis and technical analysis. It also suggests that since investment pros can't beat the stock indexes, you are much better off investing in an index fund.
This is an investment classic expanding on the merits of a couple of investment theories. One is the Efficient Market Theory whereby all information about a stock is efficiently disseminated among investors. As a result, stock prices already capture all relevant information. And, there are no unexploited gains to be had from any additional information regarding a specific stock. The second one is the Arbitrage Pricing Theory. This is the one illustrated by the metaphor: Have you picked up a $100 bill on the ground lately? Most, probably not!? In other words, there are typically no arbitrage opportunities in the stock market. Any small discrepancies in prices between various stocks and securities get arbitraged out almost immediately. To reinforce the metaphor, you may pick a couple of pennies on the ground (very small arbitrage opportunities), but certainly not large dollar bills (larger arbitrage opportunities).
These two theories reinforce the fact that stock prices move following a random pattern. Since all information is captured by investors, and investors immediately arbitrage out any infinitesimally small investment gains between themselves, you have no way of knowing where stock prices will go. Mathematically, the way to confirm this is to measure the auto correlation of the prices of a stock. In other words, you measure the correlation of a set of stock prices over time, with the same time series but using a one period lag (could be one day, one week, or anything you want). In all cases, the calculated correlation coefficient will be close to zero. This does mean that stock prices do move randomly. And, that knowing today?s stock prices does not give you any predictive information regarding tomorrow stock prices. Stock prices may go up or down. You may as well flip a coin.
In view of the above theoretical foundation, the author goes on debunking very successfully the two stock valuation models used by the investment pros:
1) Fundamental analysis; and
2) Technical analysis.
Fundamental analysis is used by security analysts. They come up with a projected earnings figure for the stock and divide it by the difference between the estimated required rate of return for that stock and the estimated earnings growth rate. The formula's result will equal the value for this stock. This value divided by the earnings per share will get you the Price/Earnings ratio on prospective earnings over the next 12 months. So far it sounds rational. Where this methodology gets tricky is that small changes in the required rate of return or the estimated earnings growth rate result in huge valuation fluctuations. And, there is no certain way to get these assumptions right (required rate of return and estimated growth rate). Another similar method, is to use a discounted cash flow model, and forecast dividends, and capital gains over a specific holding period. You then discount this cash flow stream. The resulting present value is the value of the stock. But, here again what is the proper discount rate to use in valuing that stock? The Capital Asset Pricing Model (CAPM) may help out arrive at that discount rate. But, nothing is fool proof. And, a small difference in discount rate makes a huge difference in present value. Although, these methods (fundamental analysis) are well respected by investment pros, investors, and the financial press; as described we can see how they are less than perfect. As we will soon see, they are still the best we?ve got within the field of active management.
Technical analysis, the second valuation method, consists in observing the trend of stock prices over time on a graph, and capturing different moving averages (50 day and 200 day moving averages are most common). Depending if the current stock prices is breaking above or below their respective moving average curves give you either a buy or sell signal. If you see it visually on a graph, this method is seductive. Unfortunately, it is complete bunk. Remember stock prices move randomly. Their auto correlation is zero. This is a statistical fact. Thus, it is less than surprising that technical analysis does not hold the same credibility as fundamental analysis within the investment community. Thus, if the author considered fundamental analysis less than perfect; he rightfully considers technical analysis completely flawed.
As you can imagine this book is not popular with investment professionals, including brokers who are trying to sell you specific stocks. The debates regarding the Efficient Market Theory and Arbitrage Pricing Theory are raging. And, they always will. Invariably, you will find a group of investment experts who will refute these theories. But, if the market is not efficient, it is extremely tough to exploit these inefficiencies on a sustainable basis. Just ask the Nobel Prize winners in investment theory who were the former directors of Long Term Capital Management which turned into Short Term Capital Destruction.
So, what is an investor to do if pros can't beat the average return as represented by indexes. It is simple, just invest in the index yourself through an index fund. Over time, you will beat a majority of the pros (a lot more than just the average suggests). This is because the pros returns are dragged by operating costs, trading costs, and taxes on short term gains.
on August 4, 2003
If you only read six books about the market, this should be one of them. As well as being fun to read, "Random Walk" has finally, after 30 years of revisions and improvements, become a useful investment guide.
There is more than one appoach to success in the market. Some of them actually work, but they require more time and effort than most people have to spend. If, like most of us, you want to concentrate on your career and family and investment is a sideline then this book is for you. If I were to paraphrase the thrust of this book it would be, "First of all, do no harm."
Even if you follow a different approach, you would ignore the data in this book at your peril.
on October 31, 2005
A Random Walk needs to be the first book you read about the stock market.
Malkiel is best known as a proponent of efficient markets -- the idea that stocks are correctly valued. If everyone believed that a stock was undervalued or overvalued, investors would act accordingly and en masse to correct the price. This is a fundamental tenet of the stock market that all investors must internalize before they invest. The stock market suffers from the economic version of the Heisenberg Uncertainty Principle -- any belief in a given strategy alters the market itself. This is not to say that Malkiel doesn't believe that stocks can at times be incorrectly valued. The point is that one needs knowledge of a given industry to take advantage of it. For example, if you work in the oil industry and understand drilling techniques in great detail, you could exploit this knowledge.
Malkiel goes on to thoroughly destroy the holy grail of Wall Street mavens: technical analysis. This form of analysis is based on the idea that past performance can predict future success based solely on the chart of the stock. In fact, such analysts are often called "chartists". Any one of hundreds of mathematical techniques exist that examine chart behavior -- Bollinger Bands, moving averages, Cup-and-Handle, and so on. All of them are more-or-less totally worthless, since they suffer from the uncertainty principle described above. Malkiel provides damning statistics that show beyond doubt that chartists do not consistently outperform a team of monkeys tossing darts at a board. The key adverb here is "consistently". Malkiel acknowledges that proponents of one or another strategy could show streaks of success -- but that is all they are: streaks. If 1000 people flip a coin ten times, there will be some flippers who flip heads 9/10 times. The same holds for money managers.
Finally, Malkiel examines momentum investing of the type advocated by Keynes, otherwise known as the "Greater Fool Theory". The idea here is that investors can buy an overvalued, overhyped stock and sell it to an even bigger buffoon, who in turn does the same, until eventually somebody is left holding the bag. Malkiel tells the tale of the Tulip Craze in Holland, circa 1630. Tulips became the source of intense speculation, reaching astronomical prices. Eventually, people realized they were holding a bunch of plant bulbs, and the market crashed. The key here is knowing when to sell so that there is a greater fool available to buy your shares. Therein lies the rub -- there is no rational way to make that prediction. Those who did well in the late 1990s tech bubble made money using the greater fool approach. Similarly, millions of investors got creamed in the 1990s because they were the greatest fools.
Random Walk is a seminal work on investing that is not only eminently true, but well-written and entertaining.
Don't be the greatest fool. Read this book.