A Random Walk Down Wall Street: The Best Investment Guide That Money Can Buy

by Burton G. Malkiel

Some proponents of ESG investing believe that the incorporation of ethical considerations in portfolio construction will not only benefit society but can also improve investment returns.

Sustainalytics

A study done at the Massachusetts Institute of Technology found that the correlations among the raters average only 0.61 with some pairwise correlations as low as 0.42.

ESG raters cannot even agree when they are considering the same attribute, such as carbon intensity.

Should we refuse to invest because of its carbon footprint, or do we approve of the company because of their responsible investments that may ultimately lead to lower carbon emissions?

No credible studies show that ESG investing offers consistently superior long-term returns.

The most effective way to reduce an economy’s carbon intensity is to change the economic incentive to pollute.

But the broad-based investment products that advertise themselves as helping you to save the world and simultaneously increase your financial return do not deliver.

High net worth investors might consider adding a multifactor smart beta offering or a risk-parity portfolio to the overall mix of their investments.

Factor investing can potentially increase returns at the cost of assuming a somewhat different set of risk exposures than those of a standard broad-based index fund.

And investors who are able to accept the added risks inherent in leverage might examine adding a risk-parity portf...

All investors may wish to add a fund or funds dedicated to “environmentally sustainable” inve...

I continue to believe that a broad-based total stock market index fund should be the core of everyone’s portfolio.

Certainly, for investors who are starting to build an equity portfolio in planning for retirement, standard capitalization-weighted index funds are the appropriate first investments they should make.

The single most important thing you can do to achieve financial security is to begin a regular savings program and to start it as early as possible. The only reliable route to a comfortable retirement is to build up a nest egg slowly and steadily.

The secret of getting rich slowly (but surely) is the miracle of compound interest, described by Albert Einstein as the “greatest mathematical discovery of all time.” It simply involves earning a return not only on your original investment but also on the accumulated interest that you reinvest.

For individuals, home and auto insurance are a must. So is health and disability insurance. Life insurance to protect one’s family from the death of the breadwinner(s) is also a necessity. You don’t need life insurance if you are single with no dependents. But if you have a family with young children who count on your income, you do need life insurance and lots of it.

For most people, I therefore favor the do-it-yourself approach. Buy term insurance for protection and invest the difference yourself in a tax-deferred retirement plan. Such an investment plan is far superior to “whole life” or “variable life” insurance policies.

You can increase those assets more effectively by buying term insurance and investing the money you save yourself.

A reserve for any known future expenditure should be invested in a safe instrument whose maturity matches the date on which the funds will be needed.

Popularly known as T-bills, these are the safest financial instruments you can find and are widely treated as cash equivalents.

For information on purchasing T-bills directly, go to www.treasurydirect.gov.

Although stock prices do plummet, as they did so disastrously in the early 2000s as well as 2007 and early 2020 at the start of the COVID-19 pandemic, the overall return during the entire twentieth century was about 9 percent per year, including both dividends and capital gains.

As long as the world’s population continues to grow, the demand for real estate will be among the most dependable inflation hedges.

You should be aware that the real estate market is less efficient than the stock market. Hundreds of knowledgeable investors study the worth of every common stock. Only a handful of prospective buyers assess the worth of a particular property. Hence, individual pieces of property are not always appropriately priced.

You may also wish to consider ownership of commercial real estate through the medium of real estate investment trusts (REITs, pronounced “reets”). Properties from apartment houses to office buildings and shopping malls have been packaged into REIT portfolios and managed by professional real estate operators.

Now, however, investors have a rapidly expanding group of real estate mutual funds that are more than willing to do the job for them. The funds cull through the available offerings and put together a diversified portfolio of REITs, ensuring that a wide variety of property types and regions are represented.

No man who is correctly informed as to the past will be disposed to take a morose or desponding view of the present. —Thomas B. Macaulay, History of England

Very long-run returns from common stocks are driven by two critical factors: the dividend yield at the time of purchase, and the future growth rate of earnings and dividends.

Even if a company pays very small dividends today and retains most (or even all) of its earnings to reinvest in the business, the investor implicitly assumes that such reinvestment will lead to a more rapidly growing stream of dividends in the future or alternatively to greater earnings that can be used by the company to buy back its stock.

Long-run equity return = Initial dividend yield + growth rate.

Over shorter periods, such as a year or even several years, a third factor is critical in determining returns. This factor is the change in valuation relationships—specifically, the change in the price-dividend or price-earnings multiple.

When interest rates are low, stocks, which compete with bonds for an investor’s savings, tend to sell at low dividend yields and high price-earnings multiples. When interest rates are high, stock yields rise to be more competitive and stocks tend to sell at low price-earnings multiples.

Firms that buy back stock tend to reduce the number of shares outstanding and therefore increase earnings per share and, thus, share prices. Hence, stock buybacks tend to create capital gains. Even when dividends and capital gains are taxed at the same rate, capital-gains taxes can be deferred until the stocks are sold, or even avoided completely if the shares are later bequeathed. Thus, managers acting in the interest of the shareholder will prefer to engage in buybacks rather than increasing dividends.

A significant part of management compensation is derived from stock options, which become valuable only if earnings and the price of the stock rise. Stock repurchases are an easy way to bring this about.

Larger appreciation benefits the managers by enhancing the value of their stock options, whereas larger dividends go into the pockets of current shareholders.

The principle to keep in mind is that bond investors who don’t hold to maturity will suffer to the extent that interest rates rise and gain to the extent that rates fall.

President Harry Truman was responsible for a widely used definition of the difference between the two: “A recession is when you’re out of work. A depression is when I’m out of work.”

Stocks failed to provide investors with protection against inflation, not because earnings and dividends failed to grow with inflation, but rather because price-earnings multiples quite literally collapsed over the period.

I suspect that stock investors weren’t irrational when they caused a sharp drop in price-dividend and price-earnings multiples—they were just scared.

Equity securities (dare I say equity insecurities) were, therefore, considered riskier and deserving of higher risk compensation.* The market provides higher risk premiums through a drop in prices relative to earnings and dividends; this produces larger returns in the future consistent with the new, riskier environment.

The most important investment decision you will probably ever make concerns the balancing of asset categories (stocks, bonds, real estate, money-market securities, and so on) at different stages of your life.

Less than 10 percent of investment success is determined by the specific stocks or mutual funds that an individual chooses.

History shows that risk and return are related.

The risk of investing in common stocks and bonds depends on the length of time the investments are held. The longer an investor’s holding period, the lower the likely variation in the asset’s return.

Dollar-cost averaging can be a useful, though controversial, technique to reduce the risk of...

Rebalancing can reduce risk and, in some circumstances, increase...

You must distinguish between your attitude toward and your...

A substantial amount (but not all) of the risk of common-stock investment can be eliminated by adopting a program of long-term ownership, reinvesting dividends, and sticking to it through thick and thin (the buy-and-hold strategy discussed in earlier chapters).

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.