A Random Walk Down Wall Street - Part One 1: Stocks and Their Value

Preface

1. Investors would be far better off buying and holding an index fund than attempting to buy and sell individual securities or actively managed mutual funds.

2. The basic thesis of the book: the market prices stocks so efficiently that a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed by the experts.

3. Through the past 30 years, more than two-thirds of professional portfolio managers have been outperformed by the unmanaged S&P 500 Index.

4. One’s capacity for risk-bearing depends importantly upon ones’ age and ability to earn income from noninvestment sources. It is also the case that the risk involved in most investments decreases with the length of time the investment can be held. Thus, optimal investment strategies must be age-related. 


A Random Walk Down Wall Street - The Get Rich Slowly but Surely Book Burton G. Malkiel
http://people.brandeis.edu/~yanzp/Study%20Notes/A%20Random%20Walk%20down%20Wall%20Street.pdf

Burton Malkiel - Talks at Google

How to be a millionaire? Save regularly and save early.

Dollar Cost Averaging Can Reduce the Risks of Investing in Stocks and Bonds

Dollar cost averaging is not a panacea that eliminates the risk of investing in common stocks.  

It will not save your investment plan from a devastating fall in value during a year such as 2008, because no plan can protect you from a punishing bear market.  

You must have both the cash and the confidence to continue making the periodic investments even when the sky is the darkest.

No matter how scary the financial news, no matter how difficult it is to see any signs of optimism, you must not interrupt the automatic pilot nature of the program.  

Because if you do, you will lose the benefit of buying at least some of your shares after a sharp market decline when they are for sale at low prices.  

Dollar cost averaging will give you this bargain.  Your average price per share will be lower than the average price at which you bought shares.  

Why?  Because you will buy more shares at low prices and fewer at high prices.

Some investment advisers are not fans of dollar cost averaging, because the strategy is not optimal if the market does go straight up.  (You would have been better off putting all $5,000 into the market at the beginning of the period.).  

But it does provide a reasonable insurance policy against poor future stock markets.  

And it does minimize the regret that inevitably follows if you were unlucky enough to have put all your money into the stock market during a peak period such as March of 2000 or October of 2007.

There is tremendous potential gains possible from consistently following a dollar-cost averaging program.

Because there is a long-term uptrend in common stock prices, this technique is not necessarily appropriate if you need to invest a lump sum such as a bequest.

If possible, keep a small reserve (in money fund) to take advantage of market declines and buy a few extra shares if the market is down sharply.  

Though you should not try to forecast the market, it is usually a good time to buy after the market has fallen out of bed.

Just as hope and greed can sometimes feed on themselves to produce speculative bubbles, so do pessimism and despair react to produce market panics.  

The greatest market panics are just as unfounded as the most pathological speculative explosions.  

For the stock market as a whole (not for individual stocks), Newton's law has always worked in reverse:  What goes down has come back up.  

(A Random Walk Down Wall Street, by Burton Malkiel)

Burton Malkiel: How to Invest

Uploaded on 12 Feb 2010

Princeton economist Burton Malkiel says simplicity is key to a successful portfolio. He discusses emerging markets, index funds, and more with Eric Schurenberg

Random Walk Down Wall Street by Burton Malkiel

Uploaded on 13 Sep 2011

Dr. Burton G. Malkiel, the Chemical Bank Chairman of Economics at Princeton University and author of the widely read investment book, A Random Walk Down Wall Street, shared his investment views and strategies in a talk on September 12 to SIEPR Associates.

Burton Malkiel: How to Invest

12 Feb 2010

Princeton economist Burton Malkiel says simplicity is key to a successful portfolio. He discusses emerging markets, index funds, and more with Eric Schurenberg.

Burton Malkiel: Timeless Lessons for Investors

1.  Buy and Hold.  Don't time the market

He started his talk by tackling the issue :  "In the light of the 2008 Global Financial Crisis when the market dropped almost 50%, is buy and hold is now dead?"
The best days in the market that gave the best returns were usually the few days that leaped from the bottom of the market.
Don't try to time the market.  It is dangerous.  You can't do it and you will make mistakes.

2.  Dollar Cost Averaging

You make more likely to make more money in a volatile time than a steadily rising market, but this is not always the case.  Of course, if you know the market is going to be steadily rising, you will make more money if you invest a lump sum at the beginning..

3.  Rebalance your portfolio.

He advises rebalancing your portfolio once yearly, example, 60% stock and 40% bond target and rebalancing in January every year.  In a volatile market, rebalancing reduces the volatility and may also increase the return of your portfolio.  In a rising market, rebalancing will reduce the volatiltiy and may reduce the return of your portfolio slightly.

4.  Diversification

In 2008 and early 2009, there were few places to hide.  Many people opined that diversification doesn't work anymore.
Diversification works when the asset classes are not correlated.  Though many asset classes are now more correlated, you can still diversify, example, buying emerging markets and bonds.  How do you access China?  Why not through index funds? (@39 min)

5.  Costs matter

The lower the costs charged by the purveyor of the investment service, the better and the more is left for you.  "You get what you don't pay for!"  Cost you pay is the one thing you can control and you may increase your return by up to 2% per year just by ensuing the cost is low.  He advocates index funds.  Stock market is a zero sum game and costs of mutual funds of >1% shift the distribution of the stock market to that of a negative sum game.  90% of professional managed mutual funds are beaten by the index benchmark.  In his study of mutual funds over many years, less than 5 mutual funds have beaten the market by 2% or more ( @ 29 min).  Buy the index funds.  "It is like searching for the needle in the haystack.  Buy the haystack instead.".
Two-third of bond active managers are beaten by bond-index funds.  His advice is that the core of your portfolio should be in low cost index funds. (You can have more leeway in a satellite portfolio too.)


Q&A:
@ 43 min   Lump sum investing early or Dollar Cost Averaging when you have a big sum of money to invest.
Potential regret of getting into the high of the market.  Reduction in volatility.  Might not always be optimal.  At least some of this big sum of money should still put into the market in dollar cost averaging manner. Can you advise how long to spread this dollar cost averaging?  Depends on the returns from the alternative investments.  Spread your investing over a shorter period now, since the alternative investment return (interest rate)  is low.

@ 48 min.  Missing the 10 best days or missing the 10 worst days.  Some bias in presentation.

@50.30 min.  Corporate governance.

@53 min.  Dividend yield stocks of Warren Buffett.  Buffett is really the needle in the haystack.  Vanguard REIT - a good diversifier.

@1.04.50 min.  How would you invest $1 million?

@1.08.30 min.  What are the target percentages people of various ages should save?  Answer:  MORE.  If you start early, you may have to save a lot due to the compounding effect.  Those who did not save early, probably need to save a lot more to catch up (20% or more).  The opportunity cost of not saving $1 in your 20s might be $10 or $15 when you are in your 50s.






Uploaded on 1 Jun 2010
Dr. Burton G. Malkiel, the Chemical Bank Chairman's Professor of Economics at Princeton University, is the author of the widely read investment book, A Random Walk Down Wall Street. He has also authored several other books, including the recently published The Elements of Investing.

Dr. Malkiel has long held professorships in economics at Princeton, where he was also chairman of the Economics Department. He also served as the dean of the Yale School of Management and William S. Beinecke Professor of Management Studies. Dr. Malkiel is a past president of the American Finance Association and the International Atlantic Economic Association, and a past appointee to the President's Council of Economic Advisors. He continues to serve on several corporate and investment management boards.

Burton Malkiel on his book - A Random Walk down Wall Street

A stock in the short run is essentially unpredictable.
A stock in the long run is essentially predictable (long run = decades).

A Random Walk Down Wall Street - HOW THE PROS PLAY THE BIGGEST GAME IN TOWN

A Random Walk Down Wall Street 

Investment Management
 

Chapter 6

Technical and Fundamental Analysis 

PART II – HOW THE PROS PLAY THE BIGGEST GAME IN TOWN

Part II of A Random Walk Down Wall Street concentrates on how professional work the investments game…and then how academics have concluded that the professionals aren’t worth the money you pay for them.

“…the profession of high finance is certainly one of the most generously compensated. ”  

• The stock market in the late 1990’s and early 2000’s has become “ one of the biggest games in town.”
• Players in the game are among the most highly paid people in society
• Academics study the work and results of professionals and draw conclusions about their effectiveness…academics study markets and prices and draw conclusions about their behaviour…efficiency…and espouse new theories to explain what is going on.
• This chapter introduces you to the ‘two schools of thought’ in the investments game…chartists or technicians who try to predict the future studying past trends in graphs of stock prices…and fundamental analysts who try to estimate a current intrinsic value (or inherent worth) of a stock based upon forecasts of the future in terms of cash flows, discount rates, growth rates, etc.

Technical Versus Fundamental Analysis 

• Technical analysis “is the method of predicting the appropriate time to buy or sell a stock used by those believing in the castle-in-the-air view of stock pricing.”

• Fundamental analysis “is the technique of applying the tenets of the firm-foundation theory to the selection of individual stocks.

Technical Analysis 

• Chartists study both the past movements of common stock prices and trading volume for a clue to the direction of future change.

UNDERLYING ASSUMPTION

• That the market is only 10 percent logical and 90 percent psychological
• The key to the game is to anticipate how other people play the game.
• Chartists hope that careful study of past behaviour will shed light on what the crowd is likely to do in the future.

Fundamental Analysis 

• Fundamental analysts seek to determine an issue’s proper value.
• Value is determined through forecasts for growth, dividend payout, interest rates and risk.
• The goal is to identify undervalued securities that can be purchases prior to their rise to the proper value…or short sale of overvalued securities prior to their fall to their proper value.

UNDERLYING ASSUMPTION

• That the market is only 90 percent logical and 10 percent psychological
• The key to the game is to be a superior analyst capable of identifying unrealized value…that eventually be discovered by the street.

What Can Charts Tell You? 

Principles of Technical Analysis:

• A chart showing past prices and volume of trading contains all of the information that a security analyst needs to know.
• Prices tend to move in trends (moving market prices have ‘momentum’ and stocks at rest tend to remain at rest.)  Trends tend to continue until something happens to change the supply-demand balance.

Chartist Vocabulary 

• Double bottoms
• Breakthrough
• Violating the lows
• Firmed-up
• Big play
• Ascending peaks
• Buying climax
• Head and shoulders

• Areas of support
• Areas of resistance

The Rationale for Charting 

“…we can never hope to know “why” the market behaves as it does, we can only aspire to understand “how.””

Magee, ‘Technical Analysis of Stock Trends’ 

Possible explanations for why trends might tend to perpetuate themselves:

• Crowd psychology causes people to lose their individual sense of what is right and wrong.  Crowd behaviour can be predicted.
• Information asymmetry ( there may be unequal access to fundamental information about a company)…hence the people ‘in the know’  move first causing prices to change…and then slowly the rest of the market begins to join in allowing the price to show momentum.

Further Rationale for charting 

• Chartists claim the public remembers what price they paid for a stock…and make decisions with respect to that point of reference….
• This gives rise to “resistance areas”  and “support levels”

Why Might Charting Fail to Work? 

1. Chartists react only to price trends…so the trend must be established first, before they will act…with sharp reversals…they will miss most of the opportunities.
2. Chartist techniques are self-defeating…in that if a chartist makes money with a ‘system’  then others will attempt to copy this…no buy or sell signal can be worthwhile if everyone tries to act on it simultaneously.
3. Traders try to anticipate technical signals…and tend to buy before, not after, it breaks through.
4. The market is driven by highly motivated, self-interested individuals making it a highly efficient mechanism…if some people know that the stock price will go to $40 tomorrow…it will go to $40 today.  (Prices may adjust so quickly to new information as to make the whole process of technical analysis a futile exercise.)

From Chartist to Technician 

• Chartists was the term applied to people who used stock charts in the past…with the advent of computer databases, computer statistical analysis programs and graphical user interfaces…chartists have now ‘morphed’  into technicians…
• Technicians are able to convert stock price and trading volume data into a wide variety of forms and analyze this information…for example:
• 200 day moving averages
• Relative strength indicators
• Primary, secondary and tertiary waves, etc.

The Technique of Fundamental Analysis 

• The fundamentalist strives to be relatively immune to the optimism and pessimism of the crowd.
• The fundamental analyst believes there is an intrinsic value (or inherent worth) and that the price may occasionally not be equal to that…the fundamental analysts believes, however, that eventually the market will become ‘efficient’  to the mistake and that the price will move to the intrinsic value (achieve equilibrium).
• The fundamental analyst believes that there are key factors that influence the value of a stock…dividends, growth, risk and the level of interest rates.
• The higher the risk…the lower the p/e (price earnings) multiple.

Why Might Fundamental Analysis Fail to Work? 

1. The information (data) and analysis might be incorrect.
2. The security analyst’s estimate of ‘value’ might be faulty
3. The market may not correct its mistake.

Using Fundamental and Technical Analysis Together 

• 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 that its firm foundation value
• Rule 3 – Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.

Key Lessons Learned 

• Understand that there are two radically different schools of thought followed by professionals in the investment industry…and be able to recognize those in each camp through their words and actions

“the market hasn’t discounted the recent growth in earnings in the stock price as yet” 

“the stock price will encounter a zone of resistance at the $20 level”
 

Key Lessons Learned 

• Understand the there are two radically different schools of thought followed by professionals in the investment industry…and be able to recognize those in each camp through their words and actions

“the market hasn’t discounted the recent growth in earnings in the stock price as yet” (fundamental analyst) 

“the stock price will encounter a zone of resistance at the $20 level” (technical analyst) 

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http://www.powershow.com/view1/b8703-ZDc1Z/A_Random_Walk_Down_Wall_Street_powerpoint_ppt_presentation

A Random Walk Down Wall Street - PowerPoint PPT Presentation

Markets can be irrational for some time but eventually correct any irrationality ... to Roger Ibbotson, who has spent a lifetime measuring returns, more than 90% of ... – PowerPoint PPT presentation

The Random Walk Guide to Investing: Ten Rules for Financial Success

In 1973, Burton Malkiel published A Random Walk Down Wall Street, in which he argued that a blindfolded monkey could pick stocks as well as a professional investor. Though I bought a copy of Random Walk for $3.99 at the local Goodwill last year, I haven’t read it. It looks dense. I know it’s written for the layman, but it still seems rather academic.

In 2003, Malkiel published The Random Walk Guide to Investing, “a book of less than 200 pages in length that boils down the time-tested advice from Random Walk into an investment guide that [is] completely accessible for a reader who knows nothing about the securities markets and who hates numbers.”

Several patient GRS-readers have been recommending this book for the past year. When I stayed home sick yesterday, I finally found time to read it. I’m impressed. Malkiel has produced an easy-to-read straightforward investment guide that I’m happy to recommend to anyone. His philosophy matches my own:

The advice in this book is both simple and realistic. There is no magic potion in the investment world because the truth is that one doesn’t exist. There is no quick road to riches. And if someone promises you a path to overnight riches, cover your ears and close your pocketbook. If an investment idea seems too good to be true, it is too good to be true. What I offer are ten simple, time-tested rules that can build wealth and provide retirement security. Think of the rules as the proven way to get rich slowly.

Malkiel’s rules are familiar. We’ve discussed most of them here before:

1. Start saving now, not later. Don’t worry about whether the market is high or low — just begin investing. “Trust in time rather than timing,” Malkiel writes. “The secret to getting rich slowly (but surely) is the miracle of compound interest.”
2. Keep a steady course. “The most important driver in the growth of your assets is how much you save,” writes Malkiel, “and saving requires discipline.” To develop discipline, the author recommends that you learn to pay yourself first (invest before anything else, even paying bills), implement a budget, change spending habits, and pay off debt.
3. Don’t be caught empty-handed. Malkiel recommends that readers open an emergency fund. He doesn’t specify how much should be set aside, but he does cover a variety of places to put the cash: money market accounts, certificates of deposit, and online savings accounts. He also recommends purchasing term life insurance.
4. Stiff the tax collector. Make the most of tax-advantaged savings: Open an Individual Retirement Account, contribute to your company’s retirement plan, take advantage of tax-free savings for your child’s education, buy your home rather than rent. All of these things help to reduce the bite that taxes take out of your money.
5. Match your asset mix to your investment personality. Based on your risk tolerance and your investment horizon, choose the best mix of cash, bonds, stocks, and real estate. (Malkiel encourages investors to buy each of these through mutual funds.)
6. Never forget that diversity reduces adversity. Don’t just buy stocks — buy stocks, bonds, and other investments classes. Within each category, diversify further. And don’t just buy one stock — buy mutual funds of many stocks. (Malkiel makes his case with the stark example of a 58-year-old Enron employee who had a $2.5 million 401k — of Enron stock. When Enron went bust, the employee not only lost her job, but her retirement savings vanished completely.) Finally, the author recommends “diversification over time” — making investments at regular intervals using dollar-cost averaging.
7. Pay yourself, not the piper. Interest and fees are drags on your wealth. “Paying off credit card debt is the best investment you will ever make.” Avoid expensive mutual funds. “The only factor reliably linked to future mutual fund performance is the expense ratio charged by the fund.” In fact, the author advises that costs matter for all financial products.
8. Bow to the wisdom of the market. “No one can time the market,” Malkiel says. It’s too unpredictable. Professional money managers can’t beat the market, financial magazines can’t beat the market — nobody can beat the market on a regular basis. The best way to earn consistent gains is to invest in broad-based index funds. It’s boring, but it works.
9. Back proven winners. After Malkiel has preached the virtues of index funds, presumably converting the reader to his religion, he spends a chapter suggesting possible index funds and asset allocations.
10. Don’t be your own worst enemy. Malkiel concludes by admonishing readers to stay the course, warning them against faulty thinking. He discusses the sort of money mistakes I’ve mentioned before: overconfidence, herd behavior, loss aversion, and the sunk-cost fallacy.

Ultimately, Malkiel’s advice can be stated in a few short sentences: Eliminate debt. Establish an emergency fund. Begin making regular investments to a diversified portfolio of index funds. Be patient. But the simplicity of his message does not detract from its value. The Random Walk Guide to Investing is an excellent book because it sticks to the basics:

• It’s short.
• It’s written in plain English — there’s no jargon.
• It’s easy to understand — concepts are simplified so the average person can grasp them.
• It’s filled with great advice.

This book refers often to other books to bolster its arguments, and includes quotes from financial professionals like John Bogle and Warren Buffett. Though the advice may seem elementary, it’s advice that works. If you want to invest but don’t know where to start, pick up The Random Walk Guide to Investing at your local library.

http://www.getrichslowly.org/blog/2007/12/18/the-random-walk-guide-to-investing-ten-rules-for-financial-success/


Malkiel is a proponent of the Efficient-Market Hypothesis. The idea is that markets have in them all the information they need to perform efficiently and an individual investor will not be able to outperform them consistently.