Wednesday, January 9, 2013

Book Review: A Random Walk Down Wallstreet

Not wanting to take my financial knowledge for granted, I decided to go back to some financial and investing roots and review A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing.  Originally written by economics professor and investing guru Burton G. Malkiel, this 2002 update looks more deeply into the latest dotcom bubble and lends further support to his original investing rules.
The book is essentially divided into three sections which consist of a history of market bubbles going back to Tulip Bulb Mania in the Netherlands, a section on explaining why most investing strategies fail, and then he finally wraps it up with some concrete advise and his own personal investing strategy.
History of Market Bubbles:
I have to admit that I was not expecting such an elaborate history lesson from an investing book, but I’ve got to give some credit to Mr. Malkiel as it was very entertaining to learn about investing failures of the past.  Malkiel classifies these market bubbles as investor’s search for the proverbial “Castle in the sky”.  Everyone is looking for a get-rich-quick scheme and sometimes this scheming can lead to worldwide investing mania.  He then goes throughout history, and ends with the latest dotcom boom and bust. 
A few things stuck out when talking about bubbles, namely that they usually revolve around some form of misunderstood technology (i.e. biotech in the 1980’s, dotcom in the 1990’s, and new investing formulas in the housing market of the 2000’s).  Another noteworthy point is that many investment professionals know that they are speculating in a bubble market, but as long as they aren’t the last one holding the asset, they can make a real quick buck.  In fact, whole fortunes are based on these trades.
Failure of Most Investment Strategies
In this section, Malkiel shows us why almost every investment professional cannot beat the overall market return given the risk (or beta) level.  Remember the Capital Asset Pricing Model?  He then looks throughout the past 100 years or so to show us why Technical analysis and even Fundamental analysis miss the mark.  He also debunks many investment strategies such as “Dogs of the Dow”, or “The January Effect”.   In the end, he ultimately shows that given  desired risk level, a diversified portfolio of index funds over multiple asset classes reduces overall risk and returns more than 3/4ths of the mutual funds out there. 
To elaborate why some mutual fund managers repeatedly beat the market year over year, Malkiel gives us a simple coin tossing analogy.  Imagine flipping a coin, heads you beat the market and tails you lose against the market.  Out of 1000 flippers, 500 of them flip heads.  They flip again (signifying another year of returns), and 250 of them get heads again.  We do this for a 3rd year and now 125 have consistently beat the market 3 years in a row. These folks would be hailed as masters of the market, but instead they just got lucky.  I have to admit, I was a little disappointed with this realization.  Knowing that no one knows what’s going on out there is a little disheartening to your average investor, but there is hope.
Malkiel’s Investing Strategy:
As mentioned before, Malkiel’s strategy is not a complicated one.  In fact, you can achieve complete market protection with just three simple index funds such as a total stock index, total bond index, and an international index.  He goes further into giving advice on dollar cost averaging, Treasury Inflation Protected Securities (TIPS), and even insurance tips. 
Overall, this book is a must if you are serious about investing in the market and your own future.  It’s written for all levels of investment knowledge, and even though I consider myself a little above average compared to typical investment knowledge, I did learn a bunch of new concepts.  Check it out for yourself, or ask your library.
Wonderful Moment of the Day: Made it through my PC build!  More to come on this.

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