Last week I took a variety of personal finance books out of the library-some old, some new, some new to me. One of the “old” ones is a classic but it’s still one of my favorites. That book is A Random Walk Down Wall Street.
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This book may be 40+ years old, but it’s completely timeless. Since the book’s been fully updated with the latest bubbles, the financial crisis, and investment options (unlike one of my old favorites, The Wealthy Barber) it’s just as relevent today as it was in the 1970’s. Anyone interested in investing and financial freedom needs to pick this up and read it today – and if you haven’t read it in a while, stop by the library and pick up the latest version.
This Time Is Different – Except That It’s Not
The book opens with a walk through the various bubbles and busts of history, showing that people are repetitively irrational and buy at the top/sell at the bottom.
From the Dutch tulip bulb craze of the late 1500’s and early 1600’s, to the South Sea Bubble of the 1700’s, the Great Depression of the 1920’s, the “tronic” mania of the 60’s, the dot com bubble of the 90’s, or the housing bubble of the 2000’s, everything old is new again. Only the form of the speculation changes over time. People are eager to invest in the next big thing-the thing all their neighbors, co-workers, and the internet are talking about. They’re sure to make money, because someone else did! So they buy near the top, just when the market is the most frothy-then it collapses as people sell to lock in gains, causing more to sell, and so on. As Warren Buffet famously said, be greedy when others are fearful, and fearful when others are greedy.
The tricky thing about bubbles and busts is they’re always obvious (and ridiculous!) when you look at them in the rear view mirror of history. But they’re not obvious at all when you’re in the middle of them. They look logical, and people will fear being priced out of the markets if they wait to buy. Some people always make money, but they’re the ones that got in and out early. Those stories give people hope of great riches for little risk in a short time frame. So they fall for whatever the latest craze is, convincing themselves it’s a logical choice, and only looking back can they see what it really was.
Analyzing Stock Picks – You’re Not As Good As You Think You Are
After talking through the various booms and busts of history, Mr. Malkiel has shown conclusively that human investors are irrational beings motivated by things other than rational, detailed analysis. He goes on to show how people using technical and fundamental analysis to pick stocks are both wrong and inneffective.
Interestingly the author has recommended something like an index fund since 1973 – before the first index funds were invented in 1975. Since you’re irrational, the argument goes, just buy the market and keep buying over long time periods. I agree strongly with this, and have been an index fund investor since my early 20’s. I don’t have the time or energy to do detailed analysis of stocks, nor do I think that I’m smarter or have more information than the professionals. So I’ll stick to index funds, thankyouverymuch. If you want to learn more I highly recommend popping over to Bogleheads and pursuing both the wiki and the forum.
After talking about both of these, the author moves on to discussing modern portfolio theory, the efficient market hypothesis, and behavioral finance. Suffice it to say that an investors behavior will have the biggest lifetime impact on her (or his) financial life. You’re best of doing what you can to keep your own behavior from causing you to make poor investment choices. Write up your investment policy statement and be sure to read through it if you’re tempted to invest in “the next big thing”.
Solid Personal Finance and Investment Advice
The book continues on from providing overviews of broad financial concepts to providing practical advice to ordinary investors in the last third. It can be summed up as:
- Cover yourself with cash reserves and insurance
- Invest early and often
- Invest in index funds or ETF’s, with low costs
- Use tax-advantaged financial instruments
- Own a house – don’t rent
- Use stocks and bonds, but use commodities and precious metals sparingly
- Don’t take on so much risk you can’t sleep at night
- Stick with it for the long haul
Have you read A Random Walk Down Wall Street? What did you think? Let me know in the comments.