A Random Walk Down Wall Street – Burton Malkiel

A Random Walk Down Wall Street - Burton Malkiel

Investment Fitness Exercise:

1. Total Return Indexes

2. Cover yourself with Insurance and Cash Reserves

3. Be competitive against inflation (CDs, money market, internet banks, TIPS)

4. Dodge the Tax-Collector (IRAs, Roth IRAs, pension plans, 528)

5. Understand your objectives (Do I sleep well at night?)

6. Own your home and REITs if you want ROI on real estate

7. Understand Bonds (zero coupon, tax exempt, no-load)

8. Tread softly with Commodities (gold)

9. Avoid commission costs

10. Diversify (avoid sinkholes i.e. putting all your money in Enron)

Investors would be well advised to treat new issues with a healthy dose of skepticism.

The stock market is not a voting mechanism but a weighing mechanism. Valuation metrics have not changed. Eventually, every stock can only be worth the present value of the cash flow it is able to earn for the benefit of investors.

The four valuation rules imply that a security’s firm-foundation value (and its price-earnings multiple) will be higher the larger the company’s growth rate and the longer its duration; the larger the dividend payout for the firm; the less risky the company’s stock; and the lower the general level of interest rates.

Rule 1: Buy only companies expected to have above-average earnings growth for five or more years.

Rule 2: Never pay more for a stock than its firm foundation of value.

Rule 3: Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.

Rule 4: Trade as little as possible

There are, I believe, five factors that help explain why security analysts have such difficulty in predicting the future. These are (1) the influence of random events, (2) the production of dubious reported earnings through “creative” accounting procedures, (3) errors made by the analysts themselves, (4) the loss of the best analysts to the sales desk or to portfolio management, and (5) the conflicts of interest facing securities analysts at firms with large investment banking operations.

Just as past earnings growth cannot predict future earnings, neither can past fund performance predict future results.

Lethargy bordering on sloth remains the best investment style. The correct holding period for the stock market is forever.

Lessons from Behavioral Finance

1. Avoid Herd Behavior

2. Avoid Overtrading

3. If You Do Trade: Sell Losers, Not Winners

4. No IPOs, Hot Tips,