Malkiel, Burton

• A Random Walk Down Wall Street

  • This book is a relatively famous precursor to the conventional wisdom today espoused by such stock market experts as the Motley Fools. That is: Don't work at the market. Just put your money in a widely diversified fund with a level of risk you are comfortable with and forget about it until you're ready to retire. Of course, this book doesn't just *say* this, the author *proves* it mathematically. Along the way, there is an interesting discussion of various kinds of mutual funds (including hedge funds) and how the experts try to maximize their returns using basic mathematical rules.

    My favorite passage goes something like this: Think of the most successful companies in the market, like Cisco, Oracle, Intel, Dell and Microsoft (to name a few recent tech winners over the past several years). Malkiel asks: given a list of 200 companies at the start of the decade, could you have named any one of the top five? Top ten? Would a series of guesses by market experts by any different than what random chance would predict? Malkiel argues that it essentially would not. More interestingly, think of this: Suppose you have a box of 128 coins. You shake it up, causing half the coins to end up heads and half tails (ideally). You take the 64 remaining coins that came up heads, flip them. Take the 32 heads and flip them. And so on until you are down to 1 or 2 coins.

    Now these final coins will have been flipped 6 or 7 times and come up heads each time. Your first thought might be that they have some special property. But this is clearly false. Given a large enough set of coins (companies), some have to come up heads (have more success than average) several times in a row. These "lucky" companies' CEO's are then hailed as geniuses, etc, when in all reality they just got a lot of the breaks. Malkiel argues that you can do little better predicting which of the 128 coins will come up with seven heads in a row than you can predicting which companies will do the best. Not to say fundamental analysis is useless, but rather the market is efficient enough that this information is reliably priced into the stock.

    Thus, your best strategy is not to pick one or two companies, not to duck in and out of the market, but instead to pick a mutual fund (like an index fund) and stick to it. Those give the mathematically most profitable long-term returns. Of course, in my mind, I believe this, but my heart tells me otherwise. I invested in Intel from 1992 until 1999 and saw many money increase by a factor of roughly 20 whereas an index fund during that time increased by a factor of about 3-4. I like to think that I picked Intel through foresight, but being honest, I have to admit that I was just lucky. Now it is all in a diversified growth fund, and I sleep soundly. Regardless of your market strategy, this is an absolutely fantastic book.

Return to the Welcome Page of Doug's Library.