A Random Walk Down Wall Street

Malkiel summarizes the returns of a stock as the initial dividend plus the expected growth. Price/earnings multiples can be useful in determining the worth of a stock, but they vary widely with different market attitudes, with optimistic markets offering higher multiples and pessimistic markets offering lower multiples. Bonds are reliable if allowed to mature, but they compete with inflation, with high rates of inflation reducing the worth of bonds. During the 1947-1968 period, which Malkiel calls the Age of Comfort, stock values increased with high initial dividends and consistent growth, while bonds suffered from moderate increases in interest. From 1969-1981, which Malkiel calls the Age of Angst, severe inflation destroyed bond returns, but stocks managed to keep pace in dividends and growth with inflation. However, low price-earnings multiples increased perceived risk, reducing trust in the stock market and resulting in poor returns for both bonds and stocks. Malkiel calls the period of 1982-2000 the Age of Exuberance, because this period saw an adjustment in both stocks and bonds to the higher inflation rates of the prior period, leading to both higher returns in both markets and greater confidence among investors. The first decade of the 2000s, which Malkiel calls the Age of Disenchantment, saw multiple bubbles bursting, lowering valuations of stocks, while an increase in interest rates hurt bond returns.

From 2009-2022, both bonds and stocks produced real returns, meaning both stocks and bonds outpaced inflation in their returns, with stocks matching the successes of the Age of Exuberance, and bonds returning 2% over inflation. Malkiel predicts that bonds will not have significant returns in the following decade, noting that increases in inflation or interest rates could even lead to negative returns. For the stock market, Malkiel notes that purchases made during periods of high price-earnings multiples tend to yield lower returns over a 10-year period than those purchased with lower price-earnings multiples. As such, he predicts modest returns from the stock market over the following decade, but he cautions readers that short-term yields cannot be predicted.

Malkiel presents five principles of asset allocation: risk and return are related, risk tends to decrease over longer holding periods, dollar-cost averaging can help reduce risk, rebalancing can be used to reduce risk, and investors need to assess their own comfortability with risk depending on their financial situation. Stocks are better for younger people, as stocks realize greater returns than bonds over time. Dollar-averaging is the process of investing the same dollar amount over regular intervals, such as investing $100 each month, and it reduces risk by ensuring that more stocks are purchased at low prices and less at high prices. Dollar-averaging prevents investors from overbuying at inflated prices, and, while it will not allow investors to take full advantage of a potential boom, it prevents investors from suffering during a crash. Rebalancing involves fixing the percent equity of a portfolio, then buying or selling assets to return to that ratio each year. This technique approximates a “buy low and sell high” (358) strategy, reducing risk and potentially increasing returns.

Malkiel’s three guidelines to tailor a life-cycle investment plan are to plan for specific needs with appropriate assets, act according to one’s tolerance for risk, and save consistently in regular amounts. For younger investors, Malkiel recommends a portfolio with greater risk, using safer assets like CDs for specific goals. As the investor ages, their portfolio should shift toward less risky assets, favoring bonds and REITs, and, as retirement approaches, the portfolio should focus on providing income during retirement. Malkiel notes that relatively new life-cycle funds will rebalance the portfolio for the investor as they age, removing the investor’s need to directly rebalance each year. Annuities, in which a large sum is paid as a premium to guarantee regular payments, may be a good option for some investors, but Malkiel recommends finding low-cost annuities that also meet any needs for bequests. Malkiel’s “3 ½ %” rule states that retirees should only spend as much of their nest egg as can comfortably be returned through interest and investments over the course of a year, adjusting for inflation, interest rates, and the volatility of the market. However, Malkiel notes that, under circumstances like health issues or advanced age, after bequests are ensured, it makes more sense to spend money than invest it.

Malkiel presents three steps to start buying stocks: the “No-Brainer Step,” the “Do-It-Yourself Step,” and the “Substitute-Player Step” (377). The “No-Brainer Step” is to invest the core of a portfolio in index funds. Malkiel repeats the advantages of index funds, including low fees, the possibility to avoid taxation, and guaranteed returns consistent with the market. Of course, if the market suffers a downturn, so do index funds, but, in the long run, index funds tend to perform better than actively managed funds. Malkiel provides various breakdowns of how a portfolio might be constructed using index funds of domestic stock, foreign stock, and bonds, balancing the greater growth of emerging markets with the relative safety of investing in bonds and REITs. Though Malkiel suggests investing through multiple asset types, he notes that the reader can stop at the “No-Brainer Step” and enjoy comfortable returns over extended periods.

Malkiel gives four rules for the “Do-It-Yourself Step:” buy stocks that have established a pattern of growth to increase the likelihood of returns, avoid overpaying for stocks with higher P/E multiples to stay out of potential bubbles, look for stocks that inspire stories of anticipated growth to capitalize on caste-in-the-air thinking, and trade infrequently to keep costs and taxation at a minimum. Even with these rules, Malkiel recommends investing the core of a portfolio in index funds first. The final step, “Substitute-Player,” is hiring or subscribing to an investment advisor or management service. Malkiel notes his own conflict of interest as a current Chief Investment Officer of Wealthfront and as a member of the investment committee of Rebalance. Malkiel comments that, having read this book, the reader likely does not need an advisor, and he stresses that the reader should be careful not to overpay in fees and commissions if an advisor is hired. Largely, Malkiel supports automated advisory services, through which rebalancing is automatic, and the investor can choose a plan that aligns with their own goals and comfort with risk.

Malkiel ends the book with an example showing how an investor beginning with $100,000 in 2000 might have fared in a single index fund or a diversified portfolio. Following his own examples of diversification, the investor almost doubles their money in the decade following the year 2000, while the market itself reflects a slight loss.

Malkiel reflects on two primary criticisms of widespread index fund investing: passive investing will make the market less efficient, and common ownership with reduce competition. For the first criticism, Malkiel notes that arbitrageurs are still prevalent, and investment professionals have had better luck beating the market in recent decades. These show that the market is becoming more efficient, even as investment in index funds continues to rise. For the second criticism, Malkiel notes how index funds are often invested in multiple firms within an industry, making it in their best interests to vote in favor of competition. Overall, Malkiel concedes that index fund investors are benefiting from a market without paying the costs of participation in it, but he argues that such a benefit is the nature of a capitalist system, in which everyone can follow and benefit from the free market.