A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

by Burton G. Malkiel

least historically, the gross-yield premium from junk bonds has more than compensated for actual default experience.

diversified portfolio of higher-yielding foreign bonds, including those from emerging markets, can be a useful part of a fixed-income portfolio in a period of very low interest rates.

I recommend such a partial substitution of stocks for bonds in that part of the portfolio designed for lower risk and more stability. During periods of financial repression the standard recommendations regarding bonds need to be fine-tuned.

Over the very long run, earnings and dividends are likely to grow at roughly similar rates, and, for ease of reading, I have elected to do the analysis below in terms of earnings growth.

stock returns are determined by (1) the initial dividend yield at which the stocks were purchased, (2) the growth rate of earnings, and (3) changes in valuation in terms of price-earnings (or price-dividend) ratios.

bond returns are determined by (1) the initial yield to maturity at which the bonds were purchased and (2) changes in interest rates (yields) and therefore in bond prices for bond investors who do not hold to maturity.

The longer the time period over which you can hold on to your investments, the greater should be the share of common stocks in your portfolio.

Thus, I believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is one of the broader indexes such as the Russell 3000, the Wilshire 5000 Total Market Index, the CRSP Index, or the MSCI U.S. Broad Market Index—not the S&P 500.

investors can reduce risk by diversifying internationally, by including asset classes such as real estate in the portfolio, and by placing some portion of their portfolio in bonds and bondlike securities, including Treasury inflation-protection securities.

One adjustment that I make in my own indexed portfolio is to overweight China relative to its weight in the world index benchmark. I do so because I believe that China gets too low a weight relative to its economic importance.

I believe that investors need to put more China into their portfolios than is available in general world or emerging-market index funds. I am, however, true to my indexing beliefs and think the best way to do it is to buy a broad-based index fund of Chinese companies. Three of them that trade on the New York Stock Exchange are YAO (an index fund representing all Chinese companies available to international investors), HAO (a small-capitalization index fund that contains more entrepreneurial companies and ones with less government ownership), and TAO (a Chinese real estate fund).

The two variables that do the best job in predicting future performance are expense ratios and turnover.