Tag Archives: malkiel

A Random Walk Down Wall Street: Just The Tip of the Iceberg

Thesis: While Malkiel’s book gives an in-depth look at the basics of the world of financial markets, readers should not treat it as a substitute for professional financial advice.  

Today’s stock market is, to the average American, an incomprehensible mess of quasi-sophisticated terms, incomprehensible charts, and constant breaking news updates.  As Malkiel aptly puts it, “the stock market [is] treated like a sports event with a pre-game show, a play-by-play during trading hours, and a post-game show to review the day’s action”.  This dramatization of the markets, along with the wealth of information readily available on the internet, leads many investors to get caught up in the excitement and make misinformed purchases based on the castle-in-the air theory.  Malkiel’s book equips an investor to think rationally amongst all the madness, providing an overview of the various theories and techniques which investors subscribe to (or used to subscribe to), while including real-world examples of the instances when the public succumbed to the siren’s song.  If the world of investing was the world of mathematics, then A Random Walk Down Wall Street would be like a course in basic algebra: not quite the most fundamental building blocks of theory nor the most advanced, but arguably the most crucial.

Burton Malkiel’s writing style is perfect for the type of book he wrote – a book meant to be understood by a reader coming in with absolutely no prior experience.  He keeps the technical concepts to a bare minimum, periodically dropping jokes while still embedding graphs, charts, and tables that perfectly illustrate the logic he is arguing for (mostly concerning speculative bubbles).  He makes absolutely no assumptions about the reader’s prior knowledge, providing brief explanations of basic financial concepts ranging from fundamental and technical analysis to the fact that risk is correlated with returns.  However, I think this incredibly approachable style is somewhat of a pitfall for the book – some readers may find that they are overly confident and ready to jump in to the market, just as those who think watching CNBC and perusing Bloomberg.com might prepare them for investing.

Malkiel champions indexed mutual funds and ETFs, broadly diversified funds that allow an investor to capture the market’s returns while minimizing risk, which is certainly sound advice.  He consistently returns to the efficient market hypothesis, which I interpret as his way of constantly reminding the reader how hard it is to beat the market – also sound advice.  And he lays out wise principles in part four of the book (which, by the way, contains the vast majority of the information in the book that is truly useful to the average investor – though part one is a very entertaining read) such as how risk tolerance will vary by investor, how diversification between fixed-income securities and equities is crucial, and how important it is to start saving as early as possible.  But even if a person were to diligently read this book cover to cover and use it as their investment bible, I would not trust them to manage any significant portion of my wealth based on that alone – so why should a person trust themselves after reading just this book?  The bottom line is that while Malkiel’s advice is excellent, it is not a replacement for professional financial advice.  For example, the book claims that one should hold on to larger cash reserves as they grow older, but does not get any more specific than that, because one’s investment needs vary so much from person to person.  In reality, financial goals and needs are incredibly diverse, and cannot be grouped into a few brackets of different portfolio holdings based on age and income.  Malkiel has quite a pessimistic view of financial advisers and I think he dismisses them with too much ease.  While it is true that their fees can be high, any adviser worth his/her salt will not push their clients into funds for personal benefit.  And the personalized advice they can provide, not only on investments but on legal and tax matters, is well worth the fee.

Timing the Bottom: Two Perspectives

I have always been a contrarian investor and close follower of Warren Buffet. Some of my favorite quotes by him (often known as Buffetisms) include “If you like a stock at $8, then you should love it at $6” and “When others are fearful, be greedy; when others are greedy, be fearful.” Such logic and wisdom has led me to love turnaround stocks, or for the purposes of this blog post, commodities. After the Great Recession, commodities experienced a tremendous rise in prices like many other assets and enjoyed years of gains. Recently, however, commodities across the board have sold off. Many commodities are even hitting fresh 5 year lows trading around the same prices of 2009. Each commodity has its own story for its decline such as the major oversupply of oil and OPEC refusing to cut production – sending crude from $100 a barrel to $45 a barrel real quick. But what all commodities have in common is that their prices are in terms of U.S. dollars. Therefore, the recent rise in the U.S. dollar has put downward pressure on commodity prices in general. But with prices so low, is it time for a rebound or is there further selling to go? Moreover, should individual investors even be concerned with such a question?

An article by Leslie Josephs of the Wall Street Journal discusses how the recent plunge in commodity prices serves as a buying signal to many investors. The article cites many investor sentiments, that I share, such as crude being an attractive buy at current levels as half of the world’s production is not profitable at current levels. So my long term views are that many commodities are oversold, and I believe in attempting to enter the market at the proper timing. For example, although I view the broader market commodity indexes to rise long-term, I have also been short gold at $1,300 per ounce via calls expiring in February. I believe that if you do you due diligence and invest without emotion, you can be a successful investor. Furthermore, although timing the market may not be plausible, being familiar with general price ranges and entering at the right moment is feasible.

Many, however, will disagree with my thesis. In Burton Malkiel’s A Random Walk Down Wall Street, which can be purchased here, he discusses how Wall Street behaves more like a random walk (or stochastic variable for those familiar with stochastic calculus) than following patterns or what not. Malkiel does cite that the market does experience momentum, as positive (or negative) earnings are not reflected in the share price immediately, but rather gradually over a period of time. Furthermore, he believes that one cannot time the market, denoting poor performance of fund managers relative to the benchmark index. Malkiel actually suggests a buy-and-hold method of an index fund as the best way to grow and protect capital. While I do not disagree with Malkiel, I also believe that if an investor is confident and closely follows the market, they may be select times when he can outperform. Definitely not all the time, but on a few occasions this can occur. Which is why I agree with the buy-and-hold index fund mentality for a large portion of personal investing, but some powder such remain dry for speculative play. Furthermore, since that small portion of your portfolio would be speculative, I would recommend buying options, which has a leverage factor and added timing component due to the option’s expiry.