A Random Walk Down Wall Street – Burton Malkiel

CONTENTS
Preface
Part One
STOCKS AND THEIR VALUE
1. FIRM FOUNDATIONS AND CASTLES IN THE AIR
What Is a Random Walk?
Investing as a Way of Life Today
Investing in Theory
The Firm-Foundation Theory
The Castle-in-the-Air Theory
How the Random Walk Is to Be Conducted
2. THE MADNESS OF CROWDS
The Tulip-Bulb Craze
The South Sea Bubble
Wall Street Lays an Egg
An Afterword
3. SPECULATIVE BUBBLES FROM THE SIXTIES INTO THE NINETIES
The Sanity of Institutions
The Soaring Sixties
The New “New Era”: The Growth-Stock/New-Issue Craze
Synergy Generates Energy: The Conglomerate Boom
Performance Comes to the Market: The Bubble in Concept Stocks
The Nifty Fifty
The Roaring Eighties
The Return of New Issues
Concepts Conquer Again: The Biotechnology Bubble
ZZZZ Best Bubble of All
What Does It All Mean?
The Japanese Yen for Land and Stocks
4. THE EXPLOSIVE BUBBLES OF THE EARLY 2000s
Lituz.com
The Internet Bubble
A Broad-Scale High-Tech Bubble
Yet Another New-Issue Craze
TheGlobe.com
Security Analysts $peak Up
New Valuation Metrics
The Writes of the Media
Fraud Slithers In and Strangles the Market
Should We Have Known the Dangers?
The U.S. Housing Bubble and Crash of the Early 2000s
The New System of Banking
Looser Lending Standards
The Housing Bubble
Bubbles and Economic Activity
Does This Mean That Markets Are Inefficient?
Part Two
HOW THE PROS PLAY THE BIGGEST GAME IN TOWN
5. TECHNICAL AND FUNDAMENTAL ANALYSIS
Technical versus Fundamental Analysis
What Can Charts Tell You?
The Rationale for the Charting Method
Why Might Charting Fail to Work?
From Chartist to Technician
The Technique of Fundamental Analysis
Three Important Caveats
Why Might Fundamental Analysis Fail to Work?
Using Fundamental and Technical Analysis Together
6. TECHNICAL ANALYSIS AND THE RANDOM-WALK THEORY
Holes in Their Shoes and Ambiguity in Their Forecasts
Is There Momentum in the Stock Market?
Just What Exactly Is a Random Walk?
Some More Elaborate Technical Systems
The Filter System
The Dow Theory
The Relative-Strength System
Lituz.com
Price-Volume Systems
Reading Chart Patterns
Randomness Is Hard to Accept
A Gaggle of Other Technical Theories to Help You Lose Money
The Hemline Indicator
The Super Bowl Indicator
The Odd-Lot Theory
Dogs of the Dow
January Effect
A Few More Systems
Technical Market Gurus
Why Are Technicians Still Hired?
Appraising the Counterattack
Implications for Investors
7. HOW GOOD IS FUNDAMENTAL ANALYSIS? THE EFFICIENT-MARKET
HYPOTHESIS
The Views from Wall Street and Academia
Are Security Analysts Fundamentally Clairvoyant?
Why the Crystal Ball Is Clouded
1. The Influence of Random Events
2. The Production of Dubious Reported Earnings through “Creative”
Accounting Procedures
3. Errors Made by the Analysts Themselves
4. The Loss of the Best Analysts to the Sales Desk, to Portfolio
Management, or to Hedge Funds
5. The Conflicts of Interest between Research and Investment Banking
Departments
Do Security Analysts Pick Winners? The Performance of the Mutual Funds
The Semi-Strong and Strong Forms of the Efficient-Market Hypothesis
(EMH)
A Note on High-Frequency Trading (HFT)
Part Three
THE NEW INVESTMENT TECHNOLOGY
8. A NEW WALKING SHOE: MODERN PORTFOLIO THEORY
The Role of Risk
Defining Risk: The Dispersion of Returns
Lituz.com
Illustration: Expected Return and Variance Measures of Reward and Risk
Documenting Risk: A Long-Run Study
Reducing Risk: Modern Portfolio Theory (MPT)
Diversification in Practice
9. REAPING REWARD BY INCREASING RISK
Beta and Systematic Risk
The Capital-Asset Pricing Model (CAPM)
Let’s Look at the Record
An Appraisal of the Evidence
The Quant Quest for Better Measures of Risk: Arbitrage Pricing Theory
The Fama-French Three-Factor Model
A Summing Up
10. BEHAVIORAL FINANCE
The Irrational Behavior of Individual Investors
Overconfidence
Biased Judgments
Herding
Loss Aversion
Pride and Regret
Behavioral Finance and Savings
The Limits to Arbitrage
What Are the Lessons for Investors from Behavioral Finance?
1. Avoid Herd Behavior
2. Avoid Overtrading
3. If You Do Trade: Sell Losers, Not Winners
4. Other Stupid Investor Tricks
Does Behavioral Finance Teach Ways to Beat the Market?
11. IS “SMART BETA” REALLY SMART?
What Is “Smart Beta”?
Four Tasty Flavors: Their Pros and Cons
1. Value Wins
2. Smaller Is Better
3. Momentum and Reversion to the Mean
4. Low Volatility Can Produce High Returns
Blended Flavors and Strategies
“Smart Beta” Funds Flunk the Risk Test
Appraisal of “Smart Beta”
Lituz.com
How Well Have Factor Tilts Worked in Practice?
Value and Size Tilts
Blended Hybrid Strategies
Research Affiliates Fundamental Index™ (RAFI)
Equally Weighted Portfolio Strategies
Other Factor Tilts
Low-Beta (Low-Volatility) Strategies
Momentum Strategies
Implications for Investors
Implications for Believers in Efficient Markets
CapitalizationWeighted Indexing Remains at the Top of the Class
Part Four
A PRACTICAL GUIDE FOR RANDOM WALKERS AND OTHER INVESTORS
12. A FITNESS MANUAL FOR RANDOM WALKERS AND OTHER INVESTORS
Exercise 1: Gather the Necessary Supplies
Exercise 2: Don’t Be Caught Empty-Handed: Cover Yourself with Cash
Reserves and Insurance
Cash Reserves
Insurance
Deferred Variable Annuities
Exercise 3: Be Competitive—Let the Yield on Your Cash Reserve Keep
Pace with Inflation
Money-Market Mutual Funds (Money Funds)
Bank Certificates of Deposit (CDs)
Internet Banks
Treasury Bills
Tax-Exempt Money-Market Funds
Exercise 4: Learn How to Dodge the Tax Collector
Individual Retirement Accounts
Roth IRAs
Pension Plans
Saving for College: As Easy as 529
Exercise 5: Make Sure the Shoe Fits: Understand Your Investment
Objectives
Exercise 6: Begin Your Walk at Your Own Home—Renting Leads to
Flabby Investment Muscles
Lituz.com
Exercise 7: How to Investigate a Promenade through Bond Country
Zero-Coupon Bonds Can Be Useful to Fund Future Liabilities
No-Load Bond Funds Can Be Appropriate Vehicles for Individual Investors
Tax-Exempt Bonds Are Useful for High-Bracket Investors
Hot TIPS: Inflation-Indexed Bonds
Should You Be a Bond-Market Junkie?
Foreign Bonds
Exercise 7A: Use Bond Substitutes for Part of the Aggregate Bond
Portfolio during Eras of Financial Repression
Exercise 8: Tiptoe through the Fields of Gold, Collectibles, and Other
Investments
Exercise 9: Remember That Investment Costs Are Not Random; Some Are
Lower Than Others
Exercise 10: Avoid Sinkholes and Stumbling Blocks: Diversify Your
Investment Steps
A Final Checkup
13. HANDICAPPING THE FINANCIAL RACE: A PRIMER IN UNDERSTANDING AND
PROJECTING RETURNS FROM STOCKS AND BONDS
What Determines the Returns from Stocks and Bonds?
Four Historical Eras of Financial Market Returns
Era I: The Age of Comfort
Era II: The Age of Angst
Era III: The Age of Exuberance
Era IV: The Age of Disenchantment
The Markets from 2009 through 2014
Handicapping Future Returns
14. A LIFE-CYCLE GUIDE TO INVESTING
Five Asset-Allocation Principles
1. Risk and Reward Are Related
2. Your Actual Risk in Stock and Bond Investing Depends on the Length of
Time You Hold Your Investment
3. Dollar-Cost Averaging Can Reduce the Risks of Investing in Stocks and
Bonds
4. Rebalancing Can Reduce Investment Risk and Possibly Increase Returns
5. Distinguishing between Your Attitude toward and Your Capacity for Risk
Three Guidelines to Tailoring a Life-Cycle Investment Plan
1. Specific Needs Require Dedicated Specific Assets
2. Recognize Your Tolerance for Risk
Lituz.com
3. Persistent Saving in Regular Amounts, No Matter How Small, Pays Off
The Life-Cycle Investment Guide
Life-Cycle Funds
Investment Management Once You Have Retired
Inadequate Preparation for Retirement
Investing a Retirement Nest Egg
Annuities
The Do-It-Yourself Method
15. THREE GIANT STEPS DOWN WALL STREET
The No-Brainer Step: Investing in Index Funds
The Index-Fund Solution: A Summary
A Broader Definition of Indexing
A Specific Index-Fund Portfolio
ETFs and Taxes
The Do-It-Yourself Step: Potentially Useful Stock-Picking Rules
Rule 1: Confine stock purchases to companies that appear able to sustain
above-average earnings growth for at least five years
Rule 2: Never pay more for a stock than can reasonably be justified by a
firm foundation of value
Rule 3: It helps to buy stocks with the kinds of stories of anticipated growth
on which investors can build castles in the air
Rule 4: Trade as little as possible
The Substitute-Player Step: Hiring a Professional Wall Street Walker
The Morningstar Mutual-Fund Information Service
The Malkiel Step
A Paradox
Investment Advisers
Some Last Reflections on Our Walk
A Final Word
A Random Walker’s Address Book and Reference Guide to Mutual Funds
and ETFs
Acknowledgments from Earlier Editions
Index