A Random Walk Down Wall Street

“An investment in knowledge pays the best interest.” – Benjamin Franklin

Lessons learnt: Invest in passive index funds for a very long time with money you won’t need until retirement!

Stocks go up and stocks go down – that’s about it for my knowledge on stock markets. In A Random Walk Down Wall Street Burton G. Malkiel argues that I’m not too different from almost all financial ‘advisers’. After reading the book your knowledge has however gained two very important pieces of information:

Stocks tend to go up in the long run (by as much as 8%)
You (nor your fancy broker) can predict stocks in the short (to medium) term

In 400+ pages Malkiel will take you on a journey through topics like stocks and their value, how the pros invest, and how you should invest. In the end, you will be able to separate the wheat from the chaff and start making your next investment decisions.

Random Walk

“A random walk is one in which future steps or directions cannot be predicted on the basis of past history”. Malkiel argues that the past performance of a stock is no guarantee for future performance. He argues that a monkey throwing darts will do as well on the stock market as your next best financial ‘expert’. And he has historical data backing him up.

Throughout the 400+ pages you will be introduced to a myriad of examples, let’s discuss only one here. Let’s say that you have the opportunity to choose between investing in Apple or Microsoft. The first has grown (or stagnated) steadily for many years. The second has grown much in the last decade. Which one would you choose?

Many people would – I think – choose Apple. It’s cool, hip and trending. It has outperformed Microsoft and many other competitors. And it’s stock has been on the rise for a long time. So what could go wrong? That is exactly the same thing as people thought about internet companies at the beginning of the 2000’s – right before the dot-com crisis.

And I’m not saying Apple is a bad company. I’m saying that you don’t know if there is another Tech bubble forming, or that there won’t be any strikes at the manufacturing plants of Apple. I’m saying that the past performance of Apple (or other companies) is no guarantee for future performance. And to the question which one of the two I would buy, probably both – in an index fund.

Rationality

Malkiel argues that stock markets are rational and that’s where I disagree with him. In one of the first chapters, he writes about tulip crazes in early 1600’s – prices that didn’t correspond with reality. Later on, he describes the housing bubble, dot-com crisis, etc, etc. So how can he defend the Efficient-Market Hypothesis?

He does so by changing the argument on which a price of a stock should be based. He states that it’s about how much people are willing to pay, not X times earnings. He argues that markets will always correct themselves and that pricing is only of for a short time.

I wish to disagree (psychology graduate speaking here) and argue that psychology has much more to do with it than Malkiel lets shine through. Yes, he devotes one chapter to behavioural economics and recognizes that people are not rational. But he forgets that effects like sunk-costs influence not only the stocks people hold onto, they also affect everything from building projects to marriage duration. I would even argue that our irrationality influences how we code the computers that we let do our bidding – so I can’t understand how Malkiel argues that the markets are rational.

“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen

Investment Advice

What I do believe and appreciate is his investment advice. Although Malkiel believes in rational markets he also fully understands that predicting the future of stocks is like rolling a dice. You can’t predict which number you are going to roll, but you do know that on average you will throw 3,5 (or 7 with two dice). And so it is with stock markets, you don’t know the short term but you do know that it will go up in the long term.

Therefore you should invest with longevity in mind. Invest only money that you don’t need to access for a very long time. Let the magic of compounding interests work for you and see how twenty years of 8% interest leads to a 366% increase in your money (and not 8*20=160%).

Investing should also be passive (again – you can’t predict short-term effects for individual stocks) and in an index fund. For the long term, you won’t be able to predict if Apple and Microsoft will still be around, but you can (more safely) assume that the stock market will have grown.

To sum up, all the advice and fine details of A Random Walk Down Wall Street wouldn’t do the book justice. As a starting investor, the book has helped me a great deal to better understand the ins and outs of stocks. The practical advice is very actionable (but uses American examples) and will definitively also help you further!