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

by Burton G. Malkiel

stupidity well packaged can sound like wisdom.

At a time when tonsillectomies were very fashionable, the American Child Health Association surveyed a group of 1,000 children, eleven years of age, from the public schools of New York City, and found that 611 of these had had their tonsils removed. The remaining 389 were then examined by a group of physicians, who selected 174 of these for tonsillectomies and declared that the rest had no tonsil problem. The remaining 215 were reexamined by another group of doctors, who recommended 99 of these for tonsillectomies. When the 116 “healthy” children were examined a third time, a similar percentage were told their tonsils had to be removed. After three examinations, only 65 children remained who had not been recommended for tonsillectomies. These remaining children were not examined further, because the supply of examining physicians ran out. Numerous studies have shown similar results. Radiologists have failed to recognize the presence of lung disease in about 30 percent of the X-ray plates they read, despite the clear presence of the disease on the X-ray film. Another experiment proved that professional staffs in psychiatric hospitals could not tell the sane from the insane. The point is that we should not take for granted the reliability and accuracy of any judge, no matter how expert. When one considers the low reliability of so many kinds of judgments, it does not seem too surprising that security analysts, with their particularly difficult forecasting job, should be no e...

Of course, if your investment period is for less than a decade, no one can predict the returns you will receive with any degree of accuracy.

According to Roger Ibbotson, who has spent a lifetime measuring returns from alternative portfolios, more than 90 percent of an investor’s total return is determined by the asset categories that are selected and their overall proportional representation. Less than 10 percent of investment success is determined by the specific stocks or mutual funds that an individual chooses. In

Although you may be tired of hearing that investment rewards can be increased only by the assumption of greater risk, no lesson is more important in investment management. This fundamental law of finance is supported by centuries of historical data. The table below, summarizing

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

Those timeless lessons involve broad diversification, annual rebalancing, using index funds, and staying the course.

To be sure, index investors are free riders. They do receive the benefits that result from active trading without bearing the costs. But free riding on price signals provided by others is hardly a flaw of the capitalist system; it is an essential feature of that system. In a free-market economy we all benefit from relying on a set of market prices that are determined by others.