Barron’s: The first edition of A Random Walk Down Wall Street was published in 1973. With the benefit of hindsight, is there anything you would have written differently?
Malkiel: I can tell you honestly that it would be pretty much the same take. What I suggested in 1973 is that investors would be much better off if they had simple, low-cost index funds.
But there weren’t any index funds in 1973. The first one available for the public wasn’t started until 1976, by Vanguard.
We have a lot of information about how index funds have done, as well as the typical actively managed mutual fund. I find that consistently two-thirds ofare beaten by the indexes, and those that beat the index in one year are not necessarily the ones who beat it the next year.
Over a very, very long period, sure, there are a few people who have outperformed the index. But you can almost count them on one hand. I still believe — even more strongly than I did in 1973 — that most investors would be much better off having at least the core of their portfolio in a low-cost index fund.
The term “random walk” has become so ingrained in the investing culture. What does it actually mean?
For me, it simply means that prices are unpredictable. It also has a technical meaning that, in fact, there are certain statistical properties of prices suggesting that there is no way you can predict the future price based on what has happened in the past. And, therefore, technical analysis is really useless.
Now, the market is not actually a perfect random walk. There is a book, co-authored by my friend [MIT professor] Andy Lo, called A Non-Random Walk Down Wall Street. I don’t know how he got that title! He concludes that you can look at statistics and say, “You actually do fail the random-walk hypothesis on many occasions.” But the market is very close to a random walk.
His take on behavior finance:
When A Random Walk was fist published, behavioral finance was much less prominent than it is today. What kind of contribution have the behaviorists made?
I teach behavioral finance in my course on financial markets, and I believe the contributions are really very great. Now, behavioral finance doesn’t give you a way to beat the market. But it teaches us a lot of lessons about how to avoid mistakes. The behaviorists teach about overconfidence — that we’ve got some illusion of control, and that we tend to trade too much. And that’s absolutely right; it’s a wonderful lesson for investors.
Ibbotson Associates data suggest that, over the long haul, the markets have an average annual rate of return of something like 9½% since 1926. But average investors don’t make anything like 9½%, because they tend to get in at the top and out at the bottom.
What about portfolio managers who say they can use behavioral finance to exploit opportunities?
I don’t believe that at all. I haven’t found any of them who can exploit those opportunities. The bubbles are only so clear in retrospect.
This is a welcome development. You generally don’t see economists who are advocates of efficient markets to have a benevolent view on behavioral finance. Another big message of behavior finance which is misunderstood by most- it does not teach you about making money.