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A fantastic book for the new investor,
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This review is from: A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Tenth Edition) (Paperback)
A Random Walk Down Wall Street is a very informative and easy to read book which provides a good foundation of knowledge for anyone looking to invest successfully. In this review I will detail what I, a person new to investing, gained from the sections of the book. Throughout the book, Malkiel repeatedly argues from the perspective of market efficiency stating that, in the end, short-run changes in the prices of stocks are unpredictable. He also outlines the basics of how the market works by providing numerous easy to understand examples and analogies. He continues on to identify some of the causes of bubbles and market crashes and why they happened. After establishing a history and basis of how the markets work he then provides a guide on how to invest while keeping market efficiency in mind.
Malkiel begins the first chapter by defining a random walk. A random walk relative to the stock market simply means that the prices of stocks in a short span of time are impossible to predict. The author illustrates this point by saying that, "A blindfolded monkey throwing darts at the stock listings could select a portfolio that would do just as well as one selected by the experts" which he mentions multiple times throughout the book. He then goes on to describe two standard investment theories. The firm-foundation theory states that fluctuations in prices will be corrected to an intrinsic value. Every medium of investing has some intrinsic value which is determined by analysis of current and future conditions so when prices drop from this value it is best to invest since the change will be corrected. The castle-in-the-air theory was popularized by John Maynard Keynes and states that the most money can be made through analysis of future optimistic crowd behavior and investing before the crowd does. In the next few chapters Malkiel details various incidents of crowd behavior going awry and bringing prices sky high only to see them crash and return to roughly the same value before the craze. He prefaces this with Santayana saying that if we do not learn from the mistakes of crowd crazes we are doomed to repeat it. A few of the events presented are the Holland tulip-bulb craze, the South Sea bubble, the Wall Street crash of 1929, the biotechnology bubble, and the Internet bubble. He continues to list off and analyze bubbles and overvaluation of stocks throughout history in a chronological fashion and in each event we see that the prices always bounce back to the original values. Malkiel makes it very clear to the reader that the castle-in-the-air theory is a very risky path that can both have its bountiful returns and crushing consequences. He warns the reader about treating every hot "new issue" with skepticism and to beware before jumping on a bandwagon. The author's statement that markets are efficient becomes more and more prominent with every lesson he presents before the reader. I found this section of the book to be rather enlightening since it really shows how many times these bubbles and crashes are repeated throughout history.
After this section, Malkiel discusses technical and fundamental analyses which are the two most popular methods for forecasting future stock prices. Technical analysis is studying stock charts to find trend lines in the past to determine future stock performance whereas fundamental analysis is studying a company and scrutinizing its finances, management, and its general health. His lean towards fundamental analysis is already apparent in this section as he goes on to say that, "Many would argue that chartists are lacking in dignity and professionalism" while also stating that many technical analysts also follow the castle-in-the-air theory. After the introduction of the analyses he goes on to tear apart technical analysis with some more studies and theories going as far as likening it with astrology and even correlating the stock market with the hemlines of women's dresses. Sometimes the author comes off as mildly conceited and sarcastic throughout this part and continues to drive home the point that there is a bigger picture than just stock charts. Malkiel does show some appreciation for fundamental analysis since it has a logical base and accounts for a multiple sources of data to make judgments but he still finds it to be unsound as well. The reasons it can be faulty is detailed in the book by misrepresented financial data (Enron), analyst and human errors, and unpredictable events. At the end of it all he does admit that professional analysts can sometimes pick better stocks than an average individual investor because of the fact that they have better access to information. This section of the book was entertaining to read but I found it to be more informative of what to beware of rather than what is the importance of these analyses.
The following section is about new investment technology and the modern portfolio theory. Modern portfolio theory was invented by Harry Markowitz in the 1950s and is the basic idea of diversifying a portfolio while reducing risk and maximizing returns. The author starts off with saying that risk alone determines how negative or positive returns will be and that financial risk in the modern day is typically defined as standard deviation or variance of those returns. By utilizing the modern portfolio theory, an investor would seek a diversified portfolio with low variance and risk and a steady rate of return. However, he does stress that no matter how much a portfolio is diversified there will always be some risk. After introducing this theory, Malkiel goes on to say that minimizing risk is not always an optimal outcome since greater risk obviously yields greater rewards and goes on to introduce the concept of systematic risk. Systematic risk is the reaction of individual portfolios to general market swings which is conveniently identified by the Greek symbol beta. Stocks with a higher beta respond in greater magnitudes to changes in the stock market. He includes many examples of how beta works and when it is used but in the end concludes that no single measure is able to adequately capture systematic risk and beta, though one of the simpler measures is no exception to that. This specific chapter was probably the densest chapter out of all of them since beta is a rather difficult calculation to explain. So far I feel that in this section he has brought up multiple measures of risks but only to once again focus more on flaws rather than practicality. After discussing the numbers side of finance, Malkiel delves into behavioral finance which was fathered by Daniel Kahneman and Amos Tversky. He presents the position of behavioralists on the irrational behaviors of individual investors, specifically overconfidence, biased judgments, and herd mentality. He includes studies and graphs to back up these points and really outlines common scenarios where investors exhibit these behaviors and wraps up with a lesson to the reader on avoiding irrational behavior. This part of the book was also rather eye-opening to me. It caused me to take a step back and look at my own thinking and really see where I had an irrational mindset. The most prominent one was finding my own ways to beat the market which many new investors try to do. Malkiel follows this chapter with criticisms of the efficient-market theory (which is his overarching ideology throughout the book) and breaks each argument down with a counter of his own. He picks apart many weak critiques before getting to the more significant and heftier arguments. Some critics say that the 2008 housing bubble discredits the efficient-market theory (Jeremy Grantham even said the theory was "more or less directly responsible for the financial crisis") but the author continues to press on and says that the inflation and deflation of bubbles are impossible to predict and prices will always drop back to levels before the bubble. He really drives his point home by stating that if professional portfolio managers fail to beat the market than how can any investor really identify bubbles, trends, and patterns in advance.
So far, the author has effectively shown what not to do, what to avoid, and why in the end markets are still efficient. In the next section, he finally provides a guide on what to do. In my opinion this is the most important part of the book to someone who is completely new to investing. He starts the section with explicitly stating that this is not a guide to get rich quick and the way to getting rich is a slow but sure path that everyone should start right away. He makes it important that the reader should start saving and build a nest egg as soon as possible, have an emergency cash reserve, have insurance from a company with a high A. M. Best rating, make sure their cash reserves yield more than the inflation rate, and place investments in low-tax and tax-free accounts. He also reminds the reader to make sure their investment goals are clearly outlined and within reach all while keeping the risks in mind. In this section he describes the basic investing instruments and the different scenarios where they can be utilized. The conclusion posed at the end of this is that stocks will outperform bonds in the long run but in the short run stocks pose more risk and returns are much more unpredictable. Thus, when an investor's end-goal is ten years or later, stocks should comprise a majority of their portfolio. If an investor's end-goal is in a much shorter period, than Malkiel says that their portfolio should be diversified with investments with lower risk such as bonds. He ends the final section with investment guidelines and strategies for the reader depending on their financial scenario. This is done while reiterating some of what he has talked about in previous chapters. He advocates for index funds if the time to manage a portfolio is scarce, trade as little as possible, and to only invest in stocks with prices that can be justified with some firm foundation of value (though he still believes that the exact intrinsic value of a stock is impossible to find). He also mentions ideas from the beginning of the book and to take note of stocks that may exhibit a castle-in-the-air trend in the future but still have a firm foundation to rest on.
It has been nearly 40 years since Burton Malkiel came out with the first edition of this book and he has shown that the efficient market theory and his investment strategies have stood against the test of time and still hold water to this day. Throughout the book, he made his advocacy for the efficient market theory known while continuing to state that beating market averages is very rare even with its ups and downs. He conveys this in an entertaining and authoritative manner and always connects any topic at hand to simple scenarios and analogies that make it easy for the reader to understand while keeping them engaged. However, there are some concepts earlier in the book that I felt he discredited severely but later on admitted that they do have some worth in the big picture. He mentions that the firm-foundation and castles-in-the-air theories don't bring very reliable results and the tone he expresses this in made it seem like these theories shouldn't really be used in the modern day but in the end he validates them to some extent for stock picking. I would have also liked to see a few more chapters posing the devils advocate to efficient market theory since there is an obvious but understandable bias throughout the book. The structure of the book is very well laid out; Malkiel provides a foundation and history for the reader before advising them on how to invest successfully. For someone who is inexperienced in investing I found A Random Walk Down Wall Street to be very clear on what to avoid and how to make sound investing decisions. I would recommend that everyone read this book to gain a solid understanding of investing and planning for the future. This is a great book for the new investor but experienced and risk-seeking investors may not find the book to have as much worth. Nevertheless, this book has enormous educational value that the average person can significantly benefit from.
Reviewed by Himanshu Pandey