A Random Walk Down Wall Street makes the case that the stock market moves randomly in the short term, and it helps readers understand how they can leverage that knowledge to improve their investment strategy.
Bullet Summary
- The market moves randomly and unpredictably
- There’s a long-term upward bias though
- Don’t try to outperform the market
Full Summary
About The Author: Burton Malkiel is an American economist and writer.
Burton largely espouses the efficient-market theory over the long run. But he adds that there are exceptions and, in the short term, markets are much more random than economists had long believed.
This is a position that behavioral finance has eventually confirmed (see Thaler, 2016)
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 would have been to invest in cryptocurrencies when the hype was reaching the early majority and about to go into a buying craze.
Irrational Exuberance Exists, But It’s An Exception
Malkiel 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 the two main analyses people use to decide when to buy:
- Fundamental analysis -poring over financials and market prospects-
- 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: Better But Still Not Perfect
The author has more respect for fundamental analysis, but he says that’s also lacking.
Not only the whole idea has several flaws, but the results are poor.
He says that analysts 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 Means You Shouldn’t Try to Predict
Basically the central thesis of “A Random Walk Down Wall Street” is that stocks move in a random pattern that cannot be predicted.
The shorter the timeframe, the more random the movements will be.
Technical analysis is mostly bogus, while fundamental analysis is based on actual data, but is still poor at predicting the future.
However, long run, the trend is upward.
It’s flipping a coin – with a slight upward bias
The question is, how long:
Anything Less Than A Decade It’s Pure Randomness
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 than 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
CONS
I mostly agree with Malkiel.
Yet, there are also important holes in his theory that he should have addressed.
For example:
- What About Those Who DO Beat The Market?
Warren Buffet, following Graham’s value investing theory, and Ray Dalio, just to name two, do beat the market for long stretches of time.
What about them?
There ARE exceptions who manage to beat the market in the long run and Buffet uses fundamental analysis that Malkiel says doesn’t really work.
And it would have been interesting to read about the exceptions to the rule.
Review
Any new young man who thinks he can make money in the stock market should read “A Random Walk Down Wall Street“.
This text will hopefully help them see that trying to beat the market is mostly a fool’s errand.
As a sociologist and as a website focused on psychology and social psychology, I particularly loved the analysis of the human aspects of investing.
