A Random Walk Down Wall Street: six key takeaways

It’s one of the most famous books on investing ever written. It’s sold more than two million copies, and the 50th anniversary edition — the 13th in total — is due to be published in February. The investment philosophy set out in A Random Walk Down Wall Street, by the Princeton University economist Burton Malkiel, is very much in tune with our own at rockwealth, and if you want to deepen their knowledge of investing and the financial markets, it's a book we highly recommend you read. But what, in a nutshell, can today’s investors learn from Malkiel's book? Here are ten key takeaways.

1. Financial markets are broadly efficient

The global asset asset management industry is huge — far, far larger, in fact, than it needs to be. There are so many active fund managers and other professional investors constantly analysing market prices, and they all have access to the same information at the same time. That has made markets very efficient. In other words, at any one moment, the price of a stock reflects the very latest estimate of the entire market as to how much it’s worth. Essentially, prices move in a random fashion, in response to new information — hence the name of the book, A Random Walk Down Wall Street. So it’s actually very hard to say, at any one point in time, whether a particular stock is undervalued or overvalued.

2. Prices are often “wrong” but profiting from mispricings is hard

Just because markets are efficient, that doesn’t mean prices are always “right”. Indeed, Malkiel explains, they’re often wrong. For instance, the full effect of new information may not be immediately obvious. Some market participants may underreact to news, and some may overreact. And when there’s great uncertainty, markets can be extremely volatile, as we saw, for example, in the early stages of the global Covid-19 pandemic.  Malkiel also acknowledges that markets can make egregious mistakes, as it did with GameStop shares, which soared in value then quickly plummeted again, early in 2021. His point is, though, that “even this spectacular bubble did not provide any easy route to excess profits”. Even if markets aren’t perfectly efficient, they are efficient enough to be, as  Malkiel puts it, “extraordinarily hard to beat”.

3. Successful investing is extremely simple

“Market professionals,” Malkiel writes, “will often argue that investing properly is too complicated for ordinary people to achieve on their own. Nothing could be further from the truth. “Paradoxically, the more complicated the world becomes, the more a simple investment programme becomes the surest road to investment success.” Malkiel’s prescription for investors is very straightforward. Instead of buying individual stocks or investing in actively managed funds, he says investors should simply buy and hold a broad-based index fund, or portfolio of index funds. They should diversify, stay the course, and resist the temptation to trade more often than is strictly necessary.

4. Index investing doesn’t mean mediocre returns

One of the myths perpetuated by the fund management industry is that index fund investors only receive average returns. But, as Malkiel explains, it isn’t true, Why not? It’s mainly down to cost. The growth in popularity of index funds has driven down fees to such an extent that using them is now typically one per cent cheaper than using active managed funds, once all the costs, including trading expenses, are included. So because indexers pay less, their eventual returns are higher than those of the average active investor.  “The evidence is incontrovertible,” writes Malkiel, “that low-cost index funds do not produce mediocre performance. Index funds provide investors with returns that are a full percentage point higher than those available from the average actively managed mutual fund.”

5. The biggest challenge investors face is behavioural

Successful investing may be simple, but Malkiel also points out that it’s not necessarily easy. “What is hard,” he writes, “is having the discipline to save small amounts on a regular basis and to keep it up regardless of the inevitable crisis of the moment when news reports suggest that the sky is falling and economic disaster is sure to follow.”  All investors, Malkiel warns, are prone to what he calls “behavioural foibles”, and the first step in dealing with their pernicious effects is to recognise them. The best advice is to “bow to the wisdom of the market”, and not let the fact that you’ve made money by speculating on equities in the past fool you into thinking that you’re smarter than you are.

6. Beware of financial bubbles

Malkiel is a big fan of financial market history. Time and again, he says, history shows how the madness of crowds has inflated asset prices and led the unwary to financial ruin. All excessively exuberant markets, whether it’s in tulip bulbs or cryptocurrencies, eventually succumb to the laws of gravity.  What’s more, speculative bubbles will always persist. So how do you avoid getting sucked into them? Again, the key is to keep it simple and to know the limits of your skill and knowledge. “The ability to avoid horrendous investing mistakes,” Malkiel writes, “is probably the most important factor in preserving one’s capital and allowing it to grow. The lesson is so obvious and yet so easy to ignore.”

The 50th anniversary edition of A Random Walk Down Wall Street by Burton Malkiel is due to be published by W. W. Norton on 3rd February 2023.

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