A Random Walk Down Wall Street by Malkiel

Ref: Burton Malkiel (2003). A Random Walk Down Wall Street. Norton Publishing.

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Summary­

  • A classic overview of market fundamentals and rational investment behavior to ensure long term growth.

  • The Key to successful long-term investing- Passive buy-and-hold indexing.

  • The key to investing is not how much an industry will affect society or even how much it will grow, but rather its ability to make and sustain profits.

  • People are prone to attribute any good outcome to their own abilities. They tend to rationalize bad outcomes as resulting from unusual external events. Hindsight promotes overconfidence and fosters the illusion that the world is far more predictable than it really is.

  • The Rational Investor

    • RULE 1: A rational investor should be willing to pay a higher price for a share the larger the growth rate of dividends and earnings.

      • Corollary to Rule 1: A rational investor should be willing to pay a higher price for a share the longer an extraordinary growth rate is expected to last.

    • Rule 2: A rational investor should be willing to pay a higher price for a share, other things being equal, the larger the proportion of a company’s earnings that is paid out in cash dividends. 

    • Rule 3: A rational (and risk-averse) investor should be willing to pay a higher price for a share, other things being equal, the less risky the company’s stock.

    • Rule 4: A rational investor should be willing to pay a higher price for a share, other things being equal, the lower the interest rates.

  • Ideal: Broadly diversified portfolio of mutual funds (with annual rebalancing)

    • 33% Fixed income (VBMFX)

    • 27% US Stock (VTSMX)

    • 14% Developed Foreign Markets (VDMIX)

    • 14% Emerging markets (VEIEX)12% REITs (VGSIX)

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Fundamentals

  • Treasury Bills: T-bills offer an advantage over money-market funds and bank CD’s in that their income is exempt from state and local taxes.

  • Self Employed Plans

    • The Keogh Plan for all self-employed allows you to contribute up to 25% of your income and is deductible from taxable income. The Earning are not taxed until they are withdrawn.

  • Bonds worth consideration

    • Zero coupon bonds which allow you to lock in high yields for a predetermined length of time.

    • No-load bond mutual funds which permit you to buy shares in bond portfolios.

    • Tax-exempt bonds and bond funds for those who are fortunate enough to be in high tax brackets

    • US Treasury Inflation protected securities (TIPS)

  • Price per Earning Ratio (P/E)

    • High P/E ratios are associated with high expected growth rates.

  • Growth Rate

    • Buy only companies that are expected to have above-average earnings growth for 5+ years. An extraordinary long-run earnings growth rate is the single most important element contributing to the success of most stock investments. 

  • Long Run equity Return = Initial Dividend + Growth Rate.

    • From 1926 until 2010, common stocks provided an average annual rate of return of about 9.8%. the dividend yield for the market as a whole on January 1, 1926, was about 5%. The long run rate of growth of earnings and dividends was also about 5%.

  • Price per Earning per Growth Rate (PEG)

    • Peter Lynch at Magellan Fund would buy for his portfolio only those stocks with high growth relative to their P/E’s. This was not simply a low P/E strategy, because a stock with a 50% growth rate and a P/E of 25 (PEG ratio of ½) was deemed far better than a stock with 20% growth and a P/E of 20 (PEG ratio of 1). Beware of very high multiple stocks in which future growth is already discounted.

  • Emerging Markets: China, India, Brazil

  • The Rule of 72: Take the interest rate you earn and divide it into the number 72, and you get the number of years it will take to double your money.

  • Real Estate

    • Although rent is not deductible from income taxes, the two major expenses associated with homeownership- interest payments on your mortgage and property taxes- are deductible.

    • A good house on good land keeps its value no matter what happens to money. As long as the world's population continues to grow, the demand for real estate will be among the most dependable inflation hedges available.

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Strategies

  • For most people I recommend broad-based, Total Stock Market index funds rather than individual stocks for portfolio formation. I believe that everyone should have substantial real estate holdings and some part of one's equity holdings should be in real estate investment trusts (REIT) index mutual funds.

  • MID 20’s:

    • 70% Stocks: ½ in US stocks with good representation of smaller growth companies, ½ international stocks, including emerging market.

    • 10%: REIT’s

    • 15% Bonds: zero coupon treasury bonds, no load high-grade bond fund, some TIPS

    • 5% cash

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