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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. 

5 Investing Styles dominate today. Value Investing is fashionable again.

FIVE investing styles dominate today:

1.  Value Investors
They rely on fundamental analysis of companies' financial performance to identify stocks priced below intrinsic value (the present value of a company's future cash flows.)
Benjamin Graham and David Dodd in the 1930s.
Warren Buffett in the 1970s and 1980s.

2.  Growth Investors
They seek companies whose earnings gains promise to boost intrinsic value rapidly.
Philip Fisher late 1950s.
Peter Lynch in the 1980s.

3.  Index Investors
They buy shares that replicate a large market segment such as the S&P 500.
Endorsed by Graham for defensive investors.
John Bogle in the 1980s.

4.  Technical Investors
They use charts to glean market behaviour indiccating whether expectations are rising or falling, market trends, and other "momentum" indicators.
William O'Neill in the late 1990s.

5.  Portfolio Investors
Tney ascertain their appetite for investment risk and assemble a diversified securities protfolio bearing the risk level.
Burton G. Malkiel in early 1970s.

Be Wary of IPOs. It's Probably Overpriced.

Do you think you can make lots of money by getting in on the ground floor of the initial public offering (IPO) of a company just coming to market?

My advice is:

• that you should not buy IPOs at their initial offering price and 
• that you should never buy an IPO just after it begins trading at prices that are generally higher than the IPO price.  

Historically IPOs have been a bad deal.  In measuring all IPOs five years after their initial issuance, researchers have found that IPOs underperform the total stock market by about four percentage points per year.  

• The poor performance starts about six months after the issue is sold.  
• Six months is generally set as the "lock up" period, where insiders are prohibited from selling stock to the public.  
• Once that constraint is lifted, the price of the stock often tanks.

The investment results are even poorer for individual investors.  You will never be allowed to buy the really good IPOs at the initial offering price.  The hot IPOs are snapped up by the big institutional investors or the very best wealthy clients of the underwriting firm. 


If your broker calls to say that IPO shares will be available for you, you can bet that the new issue is a dog. 

• Only if the brokerage firm is unable to sell the shares to the big institutions and the best individual clients will you be offered a chance to buy at the initial offering price.  
• Hence, it will systematically turn out that you will be buying only the poorest of the new issues.  
• There is no strategy I am aware of likely to lose you more money, except perhaps the horse races or the gaming tables of Las Vegas.

A Random Walk Down Wall Street
by Burton G. Malkiel

A Primer On Random Walks In The Stock Market

A Primer On Random Walks In The Stock Market

Jun.10, 2010

What does it mean for stock market prices to be like a random walk? What is a random walk? Financial economists have come up with an interesting scenario to introduce the random walk to laymen. Imagine if you will, they say, a drunk who has been left at a lamp post. The drunk wants to get home, but every step he takes is in a random direction. What emerges is a very erratic trail, where the position of the drunk over time starts drifting away from lamp post but occasionally coming back to where he started.

Most economists and investors are acutely cognizant of the fact that high yield mutual funds, money market deposit accounts, and general security prices have erratic up-and-down movements from day to day. Furthermore, looking at security prices from hour to hour and minute to minute continue to show these fluctuations albeit at reduced magnitudes. These observations provided the basis for the idea that like the drunkard’s walk, stock prices move up and down and drift while adhering to strict statistical properties.

Being able to map the behavior of a stock price to a mathematical theory means that the stock price should have certain statistical properties. For example, the price of a stock, bond, or mutual fund (and its yield we suppose) should move around a mean value. Moreover, the deviation away from this mean on a daily basis should never be too positive or too negative, but instead fits into a normal distribution. Interestingly many securities show these statistical behaviors which gives credence to the theory.

The proposal that the stock market (specifically in the options market) has these mathematical properties is the basis the Nobel Prize in economics being awarded to the economists Merton and Scholes. Interested readers may find that brushing up on calculus and venturing into the field of differential equations will be helpful to understanding the mathematics.

While the success of the random walk theory is not arguable, the extent to which it is true is very much in contention. Instead of strictly fluctuating around a mean, many stock prices show “trending” or consistent movement up or down ove time. And instead of fluctuation, during stock market crashes, the price of stocks, bonds, mutual funds show precipitous declines. These inconsistencies have driven development of more accurate models but the issue is not resolved.

To the regular, layman investor who is engaged in low risk investments, mutual funds, and GNMA mutual funds over the long term, such information is not so useful for calculating returns and yields. On the other hand the veteran day trader who moves in and out of positions within hours may derive some value from these ideas.

Random Walks Down Wall Street

Random Walks Down Wall Street

In the 1960s, Eugene Fama developed a new theory about the market called the Efficient Market Hypothesis. Fama determined that, at any given time, the prices of all securities fully reflect all available information about those securities.
While that doesn't sound so radical, most people who buy and sell stocks do so with the assumption that the stocks they are buying are undervalued and therefore worth more than the purchase price. When you haggle with a car dealer over the price of a new car, you're aiming for a price that's less than retail. When you buy a stock, you're also hoping that other investors have overlooked that stock for some reason, in effect giving you the opportunity to buy for "less than retail."
However, under the Efficient Market Hypothesis, any time you buy and sell securities, you're engaging in a game of chance, not skill. If markets are efficient and current prices always reflect all information, there's no way you'll ever be able to buy a stock at a bargain price.
Fama also asserted that the price movements of a particular stock will not follow any patterns or trends at all. Past price movements cannot be used to predict future price movements. He called this the Random Walk Theory -- stock prices move in an entirely random fashion, and there's no way to ever profit from "inefficiencies" in the price of a stock.
The end results of the Efficient Market Hypothesis and Random Walk Theory are controversial. If you can't predict stock prices, and picking stocks is really a matter of luck, how are we supposed to invest? And what are all those people on Wall Street doing, anyway?
Once you've resigned yourself to never beating the market, the Random Walkers say, you can be satisfied with matching the returns of the overall market. Instead of picking stocks or individual mutual funds, you should invest in the entire stock market. You can do this by investing in index funds, special mutual funds that are designed to allow you to match the returns of the overall market.

http://finance.yahoo.com/education/begin_investing/article/101173/Random_Walks_Down_Wall_Street