Investing Made Simple
Burton Malkiel is a pretty smart guy, but he doesn't believe in genius. Malkiel is the Princeton University economist whose book, A Random Walk Down Wall Street, launched the index investing movement and popularized the academic theory known as the efficient market hypothesis. Malkiel was at the CBS MoneyWatch offices recently to plug a book he'd written with the admirable Charles Ellis, another legendary investment thinker, called Elements of Investing. It's yet another of those handbook-size hardcovers so popular with financial publishers because they make investing look simple.
The twist here, is that Malkiel really does believe investing is simple. His book can be summed up in three bullet points:
- Buy index funds
- Diversify-with stock funds (foreign and domestic) , bond funds, and cash
- Rebalance
- Try to pick hot stocks
- Chase after genius money managers and invest in their funds
- Time the market
Justin Fox wrote a whole book challenging the concept. Jeremy Grantham took a swipe at the idea in his most recent quarterly newsletter. Both believe that the most powerful force in the markets is regression to the mean (or in Grantham's case, to intrinsic value). Meaning: Emotional creatures that they are, investors swing between extremes of irrational exuberance and irrational despair. Recognizing those extremes isn't that hard, goes the argument, and if you do it, you can beat index funds in the long run.
When MoneyWatch editors challenged him with these arguments, some of it on the video, Malkiel stood his ground:
Didn't the crash disprove the wisdom of indexing? "During this so-called lost decade, index funds outperformed two-thirds of the actively managed mutual funds. Index funds weren't the problem," Malkiel said. That was true for the 10 years through December 2008 (probably because the indexes were not overloaded with tech stocks in 2000, while most mutual funds were). As of the 10 years through early February, however, the index fund most favored by Malkiel -Vanguard Total Market Index (VTSMX)-has beaten about 55 percent of all comparable funds.
Isn't it obvious that overpriced assets have to revert to a reasonable value? Malkiel's reply: "The problem is, those assets can go much higher before they turn around. Remember that Alan Greenspan first used the phrase "irrational exuberance" to describe the stock market in 1996...I've never met anyone who could time the market. I've never even met anyone who knew anyone who could." The far better solution to trying to outsmart the market is to rebalance your portfolio, which forces you to buy low and sell high, whether you think you should or not.
How about people like Jeremy Grantham, who predicted the bubble? Doesn't that mean that it's possible to do? Malkiel: "I think Jeremy Grantham is a very smart guy, but he has been pessimistic for as long as I've known him." In other words, a broken clock is always right twice a day. Grantham, of course, can point out that his funds did much better than the benchmarks during the decade.
The bottom line: Allan Roth was one of the first to point out that the Lost Decade wasn't lost at all had you followed the Malkiel strategy. To be fair, you'd have done much better still had you turned your money over to Grantham at the start of the decade. But that presumes you'd have known in advance that Grantham would be the star-and it presumes that you'd have been able to stick with him, even when he looked wrong.
I continue to side with Malkiel in this debate, on the grounds that in the real world, a simple strategy is best because you can actually execute it and stick with it. Index funds will, by definition, never be the best investments over any given time period. But they'll never be the worst, either. And their chief competitive advantage-lower costs-will never go away. Investment genius, on the other hand, is fleeting. It might be real. It might be a stuck clock. In this game, pursuit of the perfect investment is the enemy of the good result.
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