The Hindu Business Line : Investment Nuggets

As they are so fond of saying on Wall Street, it takes investors of every kind to make the stock market. In much the same vein, it takes investment gurus of every kind to enrich the treasury of investment wisdom. Meet Burton Malkiel, the author of the landmark book A Random Walk down Wall Street which popularised the thesis that "a blindfolded monkey throwing darts at the newspaper's stock pages could select a portfolio that would do just as well as one carefully selected by experts". First published in 1973, Malkiel's classic is one that every would-be investor should have in hiscollection. And while it is over 30 years old, the dominant philosophy of this book still resonates the wisdom that investors should "buy and hold" a diversified portfolio heavy on index funds that passively mirror the market; such a portfolio usually out-performs actively managed funds. The underlying rationale is that one can't beat the market. Well, technically, one can beat the market, but not profitably, because the transaction costs of trading will eat up the extra returns.

J. P. Morgan once had a friend who was so worried about his stock holdings that he could not sleep at night. The friend asked, "What should I do about my stocks?'' Morgan replied, "Sell down to your sleeping point.'' Every investor must decide the trade-off he or she is willing to make between eating well and sleeping well. High investment rewards can only be achieved at the cost of substantial risk-taking. So what is your sleeping point? Finding the answer to this question is one of the most important investment steps you must take.

"Why does indexing outmanoeuvre the best minds on Wall Street? Paradoxically, it is because the best and brightest in the financial community have made the stock market very efficient. When information arises about individual stocks or the market as a whole, it gets reflected in stock prices without delay, making one stock as reasonably priced as another. Active managers who frequently shift from security to security actually detract from performance (compared to an index fund) by incurring transaction costs."

"Every year about two-thirds of active managers are beaten by a simple index fund that buys and holds all the securities in the market. Two-thirds each year, and when you look over the past 10-20 years, it is over 80 per cent. Now, you might say, okay, but can't we find the 10 per cent or 20 per cent. And the problem is, the people who beat it in one period are not the people who beat it in the next period... the best mutual funds of the '60s, they beat the market two-to-one, but in the '70s, they were much worse. Then I took the best funds of the '70s — terrible in the '80s. The best ones in the '80s — terrible in the '90s. And that's the problem. So I say, rather than looking for the kind of needle in the haystack, buy the haystack."

"Pricing irregularities and predictable patterns in stock price returns may exist and even persist for periods of time, and markets can be influenced by fads and fashions. Eventually, however, any excesses in market valuations will be corrected."

More Stories on : Investments | People | Young Investor

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page