Summary of Burton Malkiel’s “A Random Walk Down Wall Street”
Burton Malkiel authors the book “A Random Walk Down Wall Street”, highlighting several investing strategies, truisms, myths, and axioms. According to the book, Malkiel seems to have his central premise that index funds are better investment options to an individual than other strategies used for selecting stocks. This piece provides a summary of four chapters divided into two parts: part 1 having chapters 1 and 2, and part 2 having chapters 4 and 14.
Chapter 1: Firm Foundations and Castles in the Air
In the first chapter, Burton starts by defining random walk as an instance in which future occurrences cannot be predicted based on the past occurrences (Burton 24). With regard to stock markets, Burton implies that short-term changes in stock prices cannot be precisely predicted.
According to Firm-foundation theory, every investment instrument has a strong underlying intrinsic value (Burton 29). The intrinsic value can be established through the analysis of the prevailing conditions and prospects. Burton explains the castle-in-the-air theory based on Keynes argument. The theory concentrates on psychic values, where investors concentrate on analyzing the manner in which other investors could behave in the future, rather than analyzing the intrinsic value of their stocks (Burton 32).
Chapter 2: The madness of crowds
In the second chapter, Burton explains the issue of the madness of crowds and the dangers this can pose for an investor. According to the author, the psychology of speculation cannot be distinguished from the unreasonable, absurd investors. The castle in the air theory explains the behavior of speculators (Burton 36). However, the reactions of fickle crowds in the stock market can be very harmful to investors. This is because unsustainable stock prices can persist over the years, even though they often eventually reverse themselves.
Instances of the madness of crowds are analogized in the cases of tulip-bulb craze in the 17th century, the South Sea Bubble in the 18th century, and the Wall Street in the 20th century (Burton 37). In the Tulip-Bulb craze, many tulips succumbed to nonfatal virus-mosaic. The prices went up over twenty times as people made enormous profits. These examples and the overall history show that sharp rise in prices is always accompanied by a gradual return to stability in prices.
Chapter 4: The explosive bubbles of the early 2000s
In this chapter, Burton explores the big bubbles of the 2000s, focusing on the biggest of then all; the internet bubble. The NASDAQ index rose to more than two times between 1998 and 2001, with price-earnings for individual stocks included in the index soaring to over 100 (Burton 108). The internet bubble made stocks for many technology companies that relied on the internet to soar over the roof. Amazon realized a market cap more than the total of all booksellers listed on the bourse. A study was done by Cooper, Dimitrov and Rau established that all the 63 companies that had their names changed to comply with names had their price earnings increase by over 125 percent during a ten-day period, relative to their peers who had their names intact.
The internet bubble was facilitated and encouraged by the media. The media turned the country into a sea of the investor by providing information about investing in technology companies. As a result, the turnover struck the all-time high.
Chapter 14: A life-cycle guide to investing
This chapter provides that investment decision making is centered on striking a balance between stocks, bonds, money-market securities, and real estate. There are four principles for asset allocation:
The risks associated with investing in bonds and common stocks is positively correlated with the length of time for holding the investment.
The risk of stock and bonds can be reduced by dollar-cost averaging.
One must distinguish their attitudes and capacity towards risks when investing (Burton 352).
The life-cycle investment guide includes:
Aggressive investment portfolio – individuals in their twenties can invest in common stocks and riskier international stocks.
As investors age, they cut back on riskier investment portfolios. Start investing in portfolios that pay generous dividends.
During retirement age, individuals should be weighted in bonds, regular stocks, and real estate equities (Burton 363).
Work Cited
Burton, Malkiel. “A Random Walk Down Wall Street." W.W. Norton & Company, New York. 2010.
