Learning that drives better investment decisions

Make Indexing Your Investment Strategy

Book: A Random Walk Down Wall Street

Author: Burton G. Malkiel

Genre: Personal Finance

Burton G. Malkiel is an American economist and writer, and this is the newest and 11th edition of his most famous work, a book that made its first appearance in 1973. It is a comprehensive guide to investing and covers all aspects. It provides a ton of great information on how the world of finance operates.

I found this book when I first took an interest in finance and must admit that I have bought most new editions as they have come out. I have recommended this book to those who want to learn about the investment world. In it he explains the different types of valuation methods as well as what financial people are actually doing in their jobs.

Malkiel is not writing a sales pitch here; he writes like a journalist – offering you just facts and the story while also setting out to teach from his position as a financial economist.

He breaks down investment theories in two; there is his ‘Firm-foundation theory’—that stocks have intrinsic value, and can be calculated/measured one way or another. Irving Fisher and Warren Buffett being two famous experts adherent to this type of form and theory. Then there is what Malkiel calls his ‘Castle-in-the-air’, or the ‘greater fool’ theory; picking investments based on the mood of the crowd, or what is popular at the moment. Malkiel poses that it is not difficult to make money in the stock market by indexing, and he offers the tools here for an investor to benefit most by taking a long-term view to finance.

Pay Attention to History

Investors often ignore the lessons that can be found in financial history. Avoid the “popping bubbles” that happen after ‘In’ trends go bust—and the subsequent massive losses that follow popular stocks taking a fall. Investing in the “greater fool” theory—what is popular at the moment—is risky. As Malkiel concedes, it is hard to resist the emotional pull of a potential windfall, which people believe will happen when investing for short-term buy-to-sell stocks.

Unpredictability

Stock prices are random, just like continually flipping a coin will prove as Malkiel suggests. Avoid the ‘castle-in-the-air’ camp who try to predict market trends. It is nigh impossible to predict something that fluctuates so randomly. Far better to invest skeptically and beware popular but potentially worthless trends such as the hemline indicator, or the Dow theory. Malkiel breaks all these down and explains them for you to beware.

Beware The Crystal Ball

Malkiel argues that short-term stock prices are unpredictable; they are a “random walk”, and investors should bear this in mind when trying to predict their destination. No one can predict the future with any confidence. He explains that a company’s past earnings performance provides no reliable information about its future performance. The stock market will always find a true value, or, at least, something close to it if you think for a long-term path for your investments.

Avoid Analysts

Do not be led astray by financial analysts, as Malkiel points out; these “are not dispassionate seekers of the truth.” Malkiel is also renowned for saying in the book that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” Another argument in favor of avoiding analysts who don’t necessarily have your interests at heart, and saving on the fees you will only end up paying for them.

In conclusion, investors who don’t try to profit by predicting market shifts will do better in the long run with tax-favored savings and investment plans with a diversified portfolio built up of index funds, over speculators who try their hand at short-term predictions.


Haven’t read it yet? It’s a must read!



Have you read A Random Walk Down Wall Street? How did you like it?

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DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.