In 1973, a book was published that helped to change investing forever. It was called A Random Walk Down Wall Street, and its author was BURTON MALKIEL, an economist from Princeton University.
Malkiel’s central argument was that stock markets are broadly efficient and that, as a result, stock prices move up and down in a random fashion.
Instead of trying to pick the right stocks at the right time, he argued, investors should simply invest in the whole market via low-cost index funds, ignore all the “noise” surrounding the markets and focus instead on their long-term goals.
The strategy was very novel at the time, but investors who followed it fared extremely well.
This Christmas, to mark the 50th anniversary of the book’s publication, The Evidence-Based Investor is running an exclusive, three-part interview with Burton Malkiel. It was conducted at Professor Malkiel’s home in Princeton, New Jersey, by veteran analyst JON JACOBS for a book that Jacobs is writing about competition among stock market indices.
In Part 1 of the interview, Burton Malkiel shares his thoughts on the enduring influence of A Random Walk, whose 16th Edition was published in February this year, and of which there are now more than two million copies in print.
We would like to express our gratitude Burton Malkiel, and also to Jon Jacobs for allowing us to publish these articles. We look forward to the publication of his own book in due course.
Please note that this transcript has been slightly modified for brevity and clarity.
Jon Jacobs: Professor Malkiel, your goal was to educate individual investors about how they could secure their financial futures by simply capturing the market return over long periods. Although there’ve been enormous changes in the 50 years since the first publication of your book, you’ve essentially been proved right.
Burton Malkiel: It seems to me that more and more people are accepting the idea, which they certainly didn’t at the beginning. Even Warren Buffett has, with his famous bet with hedge funds and the S&P, and with his view that in his will 90% of the assets must be invested in the Standard & Poor’s 500 index fund.
I caught a little of the (2023) annual Berkshire Hathaway meeting, and it seemed to me that one of the interesting things he said about value investing is, the problem is so many people are doing it now. And this is kind of the idea of efficient markets: that when you’ve got so many people doing this, it really makes the market extraordinarily hard to beat.
But even if you thought markets were not efficient, markets clearly are very, very hard to beat. And Buffett suggested that value investing might not be quite as good as it has been over the years, and as it certainly has been for him.
Of course, Buffett is the example that everyone uses to show that it’s possible to beat the market. And his intellectual forebear Benjamin Graham near the end of his life also said that he believed security analysis to identify superior stocks would be less rewarding in the future, and that he had become a convert to the “efficient market school of thought.”
Yes. Even Benjamin Graham of Columbia at the end of his life said that.
The other interesting thing about Berkshire Hathaway is when Buffett made the bet against hedge funds, not only did the S&P beat the hedge funds, but the S&P beat Berkshire Hathaway. Berkshire Hathaway actually beat the market in 2022, but over the last ten years it has not.
What’s the most important change you’ve noticed in the industry in the past 50 years?
First is the appreciation that indexing is not a mediocre strategy. It’s not being average, it’s being above average.
And secondly, an appreciation of costs and taxes. I often like to say that anybody who talks about markets needs to be fairly modest about what one knows and doesn’t know. But the one thing I’m absolutely sure of is, the lower the fee I pay to the purveyor of the investment service, the more there is going to be for me. And I think that understanding has definitely been a big change over 50 years.
The third one, which I think just now is becoming popular, is an appreciation of not only do you want to minimise fees, but you want to minimise taxes. The tax drag of being an active manager is just enormous. And the change that’s come about that’s become more and more popular is doing tax managed portfolios. You’ve got companies that do that like Aperio, and that will give you index performance but who use tax loss harvesting.
You have a portfolio that is optimised to let’s say the S&P 500. But the drug companies were down in that particular period. So you don’t own all the drug companies. You own a sample of them and the drug companies are down and you sell Pfizer and buy Johnson & Johnson or vice versa.
That I think is another huge change. It’s becoming more and more popular and is a major way that portfolios are managed today. And what I like to say, it’s the only sure way I know of getting an alpha — not pre-tax, but you get an after-tax alpha.
So I would say those would be my picks for the biggest changes.
And I think one other thing: competition has brought fees way down. We see this with mutual fund fees. We see this with brokerage fees. The monopoly of the New York Stock Exchange has been broken, and the Citadels of the world are trading more stocks than the specialists on the New York Stock Exchange. And the reason that brokerage charges are zero at E*TRADE and Ameritrade and so forth, is because Citadel pays the brokers for distribution and then Citadel does all of the trading.
These are the huge changes I think that we’ve seen over the last 50 years. And in general they’ve been good. In general, they’ve given the small investor a real chance.
For those who haven’t read the 2023 edition of your book, what would you say has been the biggest change or the most notable change in the post-pandemic era?
Well, one of the things that I’ve done in the 2023 edition is to talk about the changes in the market, such as the ones we’ve just gone through, but also kind of a reaffirming that indexing is the right strategy, and the fact that saving is the hardest thing for people to do.
And then, from the standpoint of a theory, the difference, the big change in theory, is behavioural finance, and the idea that investing is not only doing the right thing, but avoiding the errors. And for me, the big lessons from behavioural finance are underscoring the errors that people make and continue to make, and probably will continue to make… but at least being aware of them.
The big error in recent years was thinking, “Boy, you’re really out of touch if you buy stocks. We all know now that the only way to get rich is by buying cryptocurrencies.” So I would say that was another thing that’s new — an appreciation that the right investment strategy is doing the right things, and avoiding the errors.
In A Random Walk Down Wall Street you focused on persuading individual investors that a passive approach is superior to an active approach. But do you think you also helped to push institutional investors toward indexing strategies?
I hope so, and I think so. I’m not sure I should take credit. But if I’ve had anything to do with that, I would be very, very pleased.
ABOUT JON JACOBS
Jon Jacobs is an award-winning financial writer who develops thought leadership content for asset managers and other financial institutions. He is currently gathering material for a book about competition among stock index providers.
NEXT TIME
In Part 2, Jon Jacobs asks Burton Malkiel why it took so long for index investing to take hold?
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