Malkiel's Random Walk Goes Globalby
Under normal circumstances, a new, 10th edition of A Random Walk Down Wall Street, the classic investing guide by Princeton University economics professor Burton Malkiel, could have been a routine update job.
After all, Malkiel's advice hasn't changed from the first edition, published in 1973: Spread your investments among various asset classes and countries; keep fees low; and favor index funds over active managers who claim they can beat the market.
Yet the three years since the ninth edition of Random Walk, in 2007, have felt like a lifetime for many investors, consisting of a deep recession, a stock market crash and rebound, a housing bust, record commodity prices, a European debt crisis, rapid growth in emerging economies, and a proliferation of new investment products, including hundreds of new exchange-traded funds, or ETFs. In late December, Bloomberg Businessweek.com interviewed Malkiel, 78, about how his latest edition, to be released Jan. 10, keeps pace with changing times. Edited excerpts from the conversation follow:
Q: Your new edition has much more about investing abroad. Why?
Burton Malkiel: When that book was first published, the U.S. was almost half the world economy. Emerging economies are almost half of the world economy now. China is now the second-largest economy in the world. People are inadequately diversified and really need to be much more internationally diversified.
You've long been an advocate of index funds, but I keep hearing people say this is now a "stockpicker's market" that favors active managers. They say the concept of buy-and-hold investing is obsolete.
I don't think the data show that. Two-thirds to three-quarters of active managers are beaten by a low-cost index fund. And the one-third or so who may win in one year are not the ones who win in the next year. The old lessons are not dead. When you try to time the market, which many people do, you're more likely to do it wrong than right. If you were diversified with the asset classes I recommended, you actually just about doubled your money even in this horrible lost decade.
Everybody says we know diversification doesn't work. When all hell breaks loose—as it did in late 2007 and 2008—everything goes down together. That still doesn't negate the idea that you're better off being diversified. In 2008—this horrible year when everybody lost money—you made between 5 percent and 6 percent in a total bond market index.
So the key arguments of Random Walk haven't changed. But what is new about the 10th edition of the book?
Nobody can market-time, but once a year I suggest that one rebalance. [Rebalancing is adjusting a portfolio's mix to certain preset benchmarks, often by selling assets that have gained value while buying those that have lagged.] I've got an increased appreciation of rebalancing and have done a lot of work on it. It won't always give you an extra return, but in volatile markets it will keep your risk low or consistent with the [level right for you]. And in very volatile markets, it will tend to increase your returns.
Gold futures hit a record of $1,432.50 an ounce on Dec. 7. Yet in the book you do recommend some gold and commodities exposure to investors.
I'm not a goldbug, but I'm not anti-gold. A little sliver of gold isn't going to hurt you at all. But I'd rather own it through the stock of Freeport-McMoRan Copper & Gold (FCX), or shares of one of the gold miners, than the metal itself. Bloomberg Businessweek has done some very good reporting on the commodity markets and why some of these commodity funds have not actually done well for investors, even during a period when commodities have been very strong. My own preference is to get [commodities exposure] through stocks of companies that will benefit from commodity prices going up. And I do think commodity prices will go up.
There is a lot more in the new edition about China, about their voracious appetite for raw materials. So I am not opposed to having that kind of exposure in the portfolio, but I sure wouldn't go out and simply buy a portfolio of gold ETFs.
I've talked with individual investors who would like to buy gold as an inflation hedge but who think it looks like some sort of bubble at these prices.
Gold at $1,400 an ounce scares me, too. Still, the two largest-growing major economies in the world are China and India, and there is a culture of saving by buying gold. I'm not the kind of person who will say, "Gold is too high. Now sell it short." I just don't think anybody can time the stock market, the gold market, or any other market.
So how do investors protect themselves against inflation?
I'm not writing off bonds. I realize that Treasury Inflation Protected Securities [or TIPS] are also very expensive today, but it's one of the things I would want in my total bond market fund. I would make sure I'm invested in countries that are very rich in natural resources. Brazil not only has metals, it also has arable land and the biggest oil discovery in the Americas. I want to make sure I have some Australian securities because of huge metals and mining operations there.
The past decade has seen a lot of new, innovative financial products that didn't work out well, from subprime mortgages to collateralized debt obligations. Are there any new products that concern you?
I'm a big believer in ETFs. I'm not a big believer in the gimmicky ETFs. For example, you can buy leveraged ETFs that give returns three times that of the S&P 500 index. People don't quite understand the amount of risk that those things are. Also, it doesn't give you the rate of return that you think you're going to get.
How are your arguments—for low-cost index funds and diversification—perceived in the investing community now, compared with 1973?
When my book first came out, a Wall Street professional wrote a review in BusinessWeek, which basically said this was the biggest piece of garbage you could imagine. I've never had such a bad review in my life. Wall Street has caught up with the book. Indexing has become very, very popular. The book is now required reading for the Chartered Financial Analyst course.
You were a member of the White House Council of Economic Advisers from 1975 to 1977. Do you have any advice for President Obama?
The recent tax compromise is a very good thing. I'm much more optimistic than the consensus forecasts for the U.S. economy. [Malkiel predicts that U.S. gross domestic product will grow 4 percent in 2011, compared with a median forecast of 2.6 percent by economists surveyed by Bloomberg this month.] We're going to do very much better in 2011, and I think the president was 100 percent right in accepting the compromise.
What he needs to do: Yes, we need much more short-term stimulus, but we also need to begin to do something about the long-run fiscal problem. We're not Greece, but we can't keep going the way we are going. What I would like to see the President do is to get behind the recommendations of the debt commission [chaired by Erskine Bowles and Alan Simpson]. Yes, they're unpopular, but we really need to take those recommendations seriously and start discussing them. He has to provide the leadership.