Unbiased Analysis of Today's Healthcare Issues

A Random Walk

Written By: Jason Shafrin - Sep• 28•07

I just finished reading Burton Malkiel’s influential book A Random Walk Down Wall Street. Originally published in 1973, the book was one of the first to advocate for the creation of a “no-load, minimum-management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch the winners.” In other words, the book called for the creation of the index funds, which have become extremely popular.

The book talks about how difficult it is to pick winners, since by definition half of investors will do worse than the market and half will do better. As John Maynard Keynes stated:

Playing the stock market is analogous to entering a newspaper beauty-judging contest in which one must select the six prettiest faces out of a hundred photographs, with the prize going to the person whose selections most nearly conform to those of the group as a whole.

The book recommends a buy-and-hold strategy using dollar cost averaging. Some critics of this passive investment style claim that some individuals (e.g.: Peter Lynch and Warren Buffet) have been able to beat the market consistently. A reply would be that Mr. Lynch and Mr. Buffet have access to information which is not possessed by the typical investor. Also, mathematical probability states that when many people are betting on the market, their are bound to be a few people who have a string of winning years.

The book also talks about some historical investment crazes; or as Dr. Malkiel calls them, creating “castles in the air.” For instance:

  • Tulip Bulb craze: Tulips imported into Holland from Turkey during the 17th century gained instant popularity. According to Investopedia: “The true bulb buyers (the garden centers of the past) began to fill up inventories for the growing season, depleting the supply further and increasing scarcity and demand. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs. Many Dutch persisted in believing they would sell their hoard to hapless and unenlightened foreigners, thereby reaping enormous profits. Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value – in one month!” Eventually the market crashed and individuals who had traded the value of their home for a single tulip realized the error of their ways.
  • South Seas bubble: This financial institution was granted a monopoly over trade in the South Seas by the British government. The company was supposed to grow due to trade in slaves, as well as mineral wealth (i.e.: gold and jewels). The company even agreed to finance a large debt Britain incurred after a war. “Investors quickly saw what they perceived as value in the monopoly of the South Seas. Shares were quickly snatched up from the start… The management team of this company started hyping the stock, spouting illusions of grandeur to the investors.” After the stock price reached astronomical levels, the crash began. “Eventually word broke out that the management team had sold out completely. Investors were left holding the bag. Panic selling of the worthless shares immediately ensued. Fortunes were lost in a heartbeat.”

This book is a great read for any investor and I highly recommend it.

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3 Comments

  1. […] A Random Walk I just finished reading Burton Malkiel’s influential book A Random Walk Down Wall Street. Originally published in 1973, the book was one of the first to advocate for the creation of a “no-load, minimum-management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security […] Fatal error: Call to undefined function add_submit_it() in /home/s0329a42/public_html/wpnews/wp-content/themes/adsminded/single.php on line 24 […]

  2. InsureBlog says:

    Carnival of Personal Finance is up…

    One of my absolute favorite bloggers is Jason Shafrin, aka the Healthcare Economist. In this week’s Carnival post, he reviews a fascinating book called A Random Walk Down Wall Street. According to Jason, this 30-something book still has relevance tod….

  3. […] of Personal Finance is up at My Retirement Blog.  Included in this edition of the carnival is my review of the classic book A Random Walk Down Wall […]