A Random Walk Down Wall Street says that the stock market moves randomly in the short term. And tells you what you can do with that knowledge in your investment strategy.
- The market moves randomly and unpredictably
- There’s a long term upwards bias though
- Don’t try to outperform the market
Foundations and Castles in The Air
Burton says there are two ways of approaching investment:
- Financial Fundamentals investing (value investing)
- Castle in the air
Castle in the air is based on following trends and emotions. And it’s not necessarily a poorer alternative as it can give much higher returns. An example of Castle in the air investing is the recent hype around cryptocurrencies.
Irrational Exuberance is an Exception
The author reviews a few of the financial bubbles over the years, such as:
The author says that the markets always return to roughly the pre-crush levels. It’s because markets do tend towards efficiency and after the irrational binge they tend to get back to rational levels.
Technical Analysis: A Non-Science
Malkiel introduces fundamental analysis -poring over financials and market prospects- and technical analysis -looking at chart patterns-. He severely criticizes technical analysis, saying that most correlations are dubious and that when you focus on charts you’re focusing on the micro and losing sight of the macro.
Indeed when a completely random chart was shown to some famous “chartist”, they couldn’t tell the difference between a random walk and a real stock’s movements.
Fundamental Analysis: Still Wrong
The author has more respect for fundamental analysis, but he says that’s also lacking. No only the whole idea has several flaws, but the results are poor.
He says that analysis who were asked to predict the price of a stock within 5 years were very inaccurate. They shorten the period to one year and they were even less accurate. And it wasn’t a question of industry: no industry turned out to be easy to predict.
Random Walk: Don’t Predict
Basically the central thesis of A Random Walk Down Wall Street is that the stocks move in a random pattern which can’t be predicted. However, long run, the trend is upward.
They question is, how long:
Short Periods = Risk
The author says that the past is a very flawed indicator of the future.
Yes, over a long period of time stocks will likely outperform bonds and will beat inflation, but in the short term there’s no such guarantee. And in periods shorter of a decade, it’s basically random.
That’s why Malkiel believes that Target-Date Funds are a good idea because these de-risk as your chosen date -often retirement- approaches.
My note: this is contrary to Robbins in MONEY Master The Game, who says the idea that bonds are less risky is wrong because stocks and bonds can often move in the same direction.
Where to Invest?
If you can’t beat the market -and if even trying would require so much time and effort-, what are the alternatives? The author recommends:
- Invest in Index Funds
- (Mostly) avoid actively managed funds
- Don’t overtrade
What About Those Who DO Beat The Market?
Warren Buffet, following Graham’s value investing theory (read The Intelligence Investor) and Ray Dalio (read: Principles: Life and Work) do beat the market for long stretches of time.
What about them? There ARE exception who manage to beat the market in the long run. And it would have been interesting to read about the exceptions to the rule.
Very good book, another classic to understand the market and to convince people not to try to beat the market.
As a sociologist and as a website focused on psychology and social psychology, I particularly loved the analysis of the human aspects of investing.