A E1MBOM WAhW, OWM WALL STREET

Transcription

1 A E1MBOM WAhW, OWM WALL STREET The Time-Tested Strategy for Successful Investing BURTON G. MALKIEL W. W..NORTON & COMPANY New York London

2 COMTEMTS Preface 17 Acknowledgments from Earlier Editions 21 Part One STOCKS AND THEIR VALUE 1. FIRM FOUNDATIONS AND CASTLES IN THE AIR 25 What Is a Random Walk? 26 Investing as a Way of Life Today 28 Investing in Theory 30 The Firm-Foundation Theory 31 The Castle-in-the-Air Theory 33 How the Random Walk Is to Be Conducted THE MADNESS OF CROWDS 37 The Tulip-Bulb Craze 38.. The South Sea Bubble 41

3 8 CONTENTS Wall Street Lays an Egg 48 An Afterword SPECULATIVE BUBBLES FROM THE SIXTIES INTO THE NINETIES 56 The Sanity of Institutions 56 The Soaring Sixties 57 The New "New Era": The Growth-Stock/New-Issue Craze 57 Synergy Generates Energy: The Conglomerate Boom 60 Performance Comes to the Market: The Bubble in Concept Stocks The Nifty Fifty 69 The Roaring Eighties 70 The Return of New Issues 70 Concepts Conquer Again: The Biotechnology Bubble 72 ZZZZ Best Bubble of All 73 What Does It All Mean? 76 The Japanese Yen for Land and Stocks THE EXPLOSIVE BUBBLES OF THE EARLY 2000S 80 The Internet Bubble so A Broad-Scale High-Tech Bubble 82 Yet Another New-Issue Craze 85 TheGlobe.com 87 Security Analysts $peak Up 89 New Valuation Metrics 90 The Writes of the Media 92 Fraud Slithers In and Strangles the Market 94 Should We Have Known the Dangers? 97 The U.S. Housing Bubble and Crash of the Early 2000s 98 The New System ofbanking 99 Looser Lending Standards 101 The Housing Bubble 102 Bubbles and Economic Activity 105 Does This Mean That Markets Are Inefficient? 105

4 CONTENTS Part Two HOW THE PROS PLAY THE BIGGEST GAME IN TOWN 5. TECHNICAL AND FUNDAMENTAL ANALYSIS 111 Technical versus Fundamental Analysis 112 What Can Charts Tell You? 113 The Rationale for the Charting Method 117 Why Might Charting Fail to Work? 119 From Chartist to Technician 120 The Technique of Fundamental Analysis 121 ' Three Important Caveats 129 Why Might Fundamental Analysis Fail to Work? 133 Using Fundamental and Technical Analysis Together TECHNICAL ANALYSIS AND THE RANDOM-WALK THEORY 138 Holes in Their Shoes and Ambiguity in Their Forecasts 138 Is There Momentum in the Stock Market? 140 Just What Exactly Is a Random Walk? 142 Some More Elaborate Technical Systems 145 The Filter System 145 The Dow Theory 146 The Relative-Strength System 147 Price-Volume Systems 147 Reading Chart Patterns 148 Randomness Is Hard to Accept 149 A Gaggle of Other Technical Theories to Help You Lose Money 150 The Hemline Indicator 151 The Super Bowl Indicator 152 The Odd-Lot Theory 153 A Few More Systems 154 Technical Market Gurus 154 Why Are Technicians Still Hired? 157 Appraising the Counterattack 158 Implications for Investors 161

5 10 CONTENTS 7. HOW GOOD IS FUNDAMENTAL ANALYSIS? 163 The Views from Wall Street and Academia 164 Are Security Analysts Fundamentally Clairvoyant? 164 Why the Crystal Ball Is Clouded The Influence ofrandom Events The Production ofdubious Reported Earnings through "Creative" Accounting Procedures Errors Made by the Analysts Themselves The Loss of the Best Analysts to the Sales Desk, to Portfolio Management, or to Hedge Funds The Conflicts ofinterest between Research and Investment Banking Departments 174 Do Security Analysts Pick Winners? The Performance of the Mutual Funds 177 Can Any Fundamental System Pick Winners? 184 The Verdict on Market Timing 185 The Semi-Strong and Strong Forms of the Efficient-Market Theory 186 The Middle of the Road: A Personal Viewpoint 189 Part Three THE NEW INVESTMENT TECHNOLOGY A NEW WALKING SHOE: MODERN PORTFOLIO THEORY 195 The Role of Risk 196 Defining Risk: The Dispersion of Returns 197 Illustration: Expected Return and Variance Measures of Reward and Risk 197 Documenting Risk: A Long-Run Study 200 Reducing Risk: Modern Portfolio Theory (MPT) 202 Diversification in Practice 206

6 CONTENTS 1 9. REAPING REWARD BY INCREASING RISK 215 Beta and Systematic Risk 216 The Capital-Asset Pricing Model (CAPM) 219 Let's Look at the Record 225 An Appraisal of the Evidence 227 The Quant Quest for Better Measures of Risk: Arbitrage Pricing Theory 229 The Fama-French Three-Factor Model 231 A Summing Up BEHAVIORAL FINANCE 235 The Irrational Behavior of Individual Investors 238 Overconfidence 238 Biased Judgments 841 Herding 245 Loss Aversion 249 Pride and Regret 251 Behavioral Finance and Savings 252 The Limits to Arbitrage 254 What Are the Lessons for Investors from Behavioral Finance? Avoid Herd Behavior Avoid Overtrading If You Do Trade: Sell Losers, Not Winners Other Stupid Investor Tricks 263 Does Behavioral Finance Teach Ways to Beat the Market? POTSHOTS AT THE EFFICIENT-MARKET THEORY AND WHY THEY MISS 267 What Do We Mean by Saying Markets Are Efficient? 269 Potshots That Completely Miss the Target 270 Dogs of the Dow 271 January Effect 271 "Thank God It's Monday Afternoon" Pattern 272 Hot News Response 273 Why the Aim Is So Bad 273

7 CONTENTS Potshots That Get Close but Still Miss the Target 275 The Trendls Your Friend (Otherwise Known asshort-term Momentum) 275 The Dividend Jackpot Approach 277 The Initial P/E Predictor f 278 The "Back We Go Again" Strategy (Otherwise Known as Long-Run Return Reversals) 280 The "Smaller Is Better"Effect 283 The "Value Will Win" Record 285 Stocks with Low Price-Earnings Multiples Outperform Those with High Multiples 285 Stocks That Sell at Low Multiples of Their Book Values Tend to Produce Higher Subsequent Returns 286 Does "Value"Really Trump Growth on a Consistent Basis? 287 Why Even Close Shots Miss 289 And the Winner Is The Performance of Professional Investors 291 A Summing Up 296 Part Four A PRACTICAL GUIDE FOR RANDOM WALKERS AND OTHER INVESTORS 12. A FITNESS MANUAL FOR RANDOM WALKERS 303 Exercise 1: Gather the Necessary Supplies 304 Exercise 2: Don't Be Caught Empty-Handed: Cover Yourself with Cash Reserves and Insurance 306 Cash Reserves 306 Insurance 307 Deferred Variable Annuities 309 Exercise 3: Be Competitive Let the Yield on Your Cash Reserve. Keep Pace with Inflation 309 Money-Market Mutual Funds (Money Funds) 310

8 CONTENTS 13 Bank Certificates ofdeposit (CDs) 310 InternetBanks 311 Treasury Bills 311 Tax-Exempt Money-MarketFunds 312 Exercise 4: Learn How to Dodge the Tax Collector 312 Individual Retirement Accounts 313 RothlRAs 315 Pension Plans 316 Saving for College: As Easy as Exercise 5: Make Sure the Shoe Fits: Understand Your Investment Objectives 318 Exercise 6: Begin Your Walk at Your Own Home Renting Leads to Flabby Investment Muscles 325 ' Exercise 7: Investigate a Promenade through Bond Country 327 Zero-Coupon Bonds Can Generate Large Future Returns 328 No-Load Bond Funds Are Appropriate Vehicles for Individual Investors 329 Tax-Exempt Bonds Are Useful for High-Bracket Investors 330 Hot TIPS: Inflation-Indexed Bonds 331 Should You Be a Bond-Market Junkie? 332 Exercise 8: Tiptoe through the Fields of Gold, Collectibles, and Other Investments 333 Exercise 9: Remember That Commission Costs Are Not Random; Some Are Lower than Others 336 Exercise 10: Avoid Sinkholes and Stumbling Blocks: Diversify Your Investment Steps 337 A Final Checkup HANDICAPPING THE FINANCIAL RACE: A PRIMER IN UNDERSTANDING AND PROJECTING RETURNS FROM STOCKS AND BONDS 340 What Determines the Returns from Stocks and Bonds? 340 Four Eras of Financial Market Returns 345 Era I: The Age of Comfort 346 Era II: The Age of Angst 348

9 14 CONTENTS Era III: The Age of Exuberance 352 >. Era IV: The Age of Disenchantment 355 Handicapping Future Returns A LIFE-CYCLE GUIDE TO INVESTING 359 Five Asset-Allocation Principles Risk and Reward Are Related Your Actual Risk in Stock and Bond Investing Depends on the Length of Time You Hold Your Investment Dollar- Cost Averaging Can Reduce the Risks ofinvesting in Stocks and Bonds ' 4. Rebalancing Can Reduce Investment Risk and Possibly Increase Returns Distinguishing between Your Attitude toward and Your Capacity for Risk 371 Three Guidelines to Tailoring a Life-Cycle Investment Plan Specific Needs Require Dedicated Specific Assets Recognize Your Tolerance for Risk Persistent Saving in Regular Amounts, No Matter How Small, Pays Off 374 The Life-Cycle Investment Guide 376 Life-Cycle Funds 379 Investment Management Once You Have Retired 380 Inadequate Preparation for Retirement 381 Investing a Retirement Nest Egg 381 Annuities 382 The Do-It-Yourself Method THREE GIANT STEPS DOWN WALL STREET 389 The No-Brainer Step: Investing in Index Funds 391 The Index-Fund Solution: A Summary 392 A Broader Definition of Indexing 395 A Specific Index-Fund Portfolio 397 ETFs and the Tax-Managed Index Fund 399

10 CONTENTS 15 The Do-It-Yourself Step: Potentially Useful Stock-Picking Rules 402 Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at leastfiveyears 403 Rule 2: Never pay more for a stock than can reasonably be justified by a firm foundation of value 403 Rule 3: It helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air 404 Rule 4: Trade as little as possible 404 The Substitute-Player Step: Hiring a Professional Wall Street Walker The Morningstar Mutual-Fund Information Service 409 The Malkiel Step 410 A Paradox 413 Some Last Reflections on Our Walk 415 A Final Word 416 Supplement: How Pork Bellies Acquired an Ivy League Suit: A Primer on Derrivatives 419 Appendix to Supplement: What Determines Prices in the Futures and Options Markets? 454 A Random Walker's Address Book and Reference Guide to Mutual Funds 463 Index 471