A Random Walk Down Wall Street

A Random Walk Down Wall Street by Burton G. Malkiel was originally published in 1973, and it has had 13 editions published to date. Random Walk is a guide to investing, covering the history of crises in investment markets to aid the reader in navigating contemporary investment situations.

Random Walk presents in-depth discussions of Balancing Risk and Reward, Comparing Long-Term and Short-Term Goals, and The Psychology of Crowds and Markets, presenting the reader with a guide to navigating the market with a specific focus on what they want as investors, how much risk they are willing to maintain to achieve those goals, and what psychological trends they should identify and avoid. Malkiel emphasizes that developing wealth is not a fast process, but a program of regular saving over many years while investing is reliable, broad-based index funds. He argues index funds should form the core of anyone’s portfolio, with additional investment products and methods acting as supplements to that foundation. When Random Walk was initially published, index funds were not yet available, and Malkiel’s ideas were not widely accepted. As of 2024, however, index funds are immensely popular, and they are commonly acknowledged as a reliable source of returns for investors.

This guide uses the 13th edition of A Random Walk Down Wall Street, published by W.W. Norton & Company in 2023.

Summary

Random Walk consists of four parts, as well as an Introduction to the 50th Anniversary Edition and an Epilogue. After the body of the text, Malkiel provides an “address book” of various funds and companies that readers may want to research or contact for further information. The Introduction covers the changes in the investment landscape over the 50 years since Malkiel first wrote Random Walk, including the modern popularity of index funds, which did not exist at the time of the first edition. Malkiel expresses his hope and confidence that Random Walk can provide a complete guide to new and current investors of any age.

Part 1 addresses two major theories in investing: firm-foundation theory and castle-in-the-air theory. Firm-foundation theory asserts that stocks have concrete value, which can determine whether a stock is worth buying, while castle-in-the-air theory follows the psychology of the market to determine which stocks are going to increase in value over the short term. This part also covers the various bubble companies and booms in history that illustrate the rapid volatility of the market. Beginning with the tulip boom of 16th- and 17th-century Holland, Malkiel demonstrates how popular commodities and securities can create a kind of irrationality among investors, leading them to push up the price of the security past the point of rationality. Eventually, as with the tulip boom, investors begin to sell their assets, leading to a crash in which the asset loses almost all its value. In more contemporary times, Malkiel covers the advent of cryptocurrencies and the bubble created by meme investors with GameStop stock.

In Part 2, Malkiel follows firm-foundation theory and castle-in-the-air theory into the professional investment industry, noting how securities analysts and technicians apply these theories to active investments. Technicians, or chartists, follow castle-in-the-air theory, but they also concoct a variety of techniques for predicting the short-term fluctuations of the market. While castle-in-the-air theory attempts to ride short periods of momentum, technicians chart out the performance of a stock to find areas of momentum in many forms, with some technicians basing their decisions on seemingly arbitrary details, like women’s fashion or sunspots. Securities analysts, who Malkiel notes make up most of investment professionals, study the data behind companies, such as real assets, earnings, and performance to try to figure out the real value of the company’s stock. Once that value is determined, the securities analyst either buys a stock that is currently undervalued or sells stocks that are currently overvalued. Referencing the efficient market hypothesis, Malkiel notes that neither technique is effective in a totally efficient market, but firm-foundation theory may be able to work in only a mostly efficient market.

Part 3 focuses on risk and how modern technology has changed the investment landscape. Modern Portfolio Theory, or MPT, guides active funds managers to minimize risk for their investors while attempting to beat the market. The basis of this theory is diversification, in which investors spread their investments across multiple assets and asset types to balance out the risks of individual assets with those of others, resulting in an overall reduction in risk without sacrificing returns. Within discussions of risk, Malkiel covers the concept of beta, or systematic risk, which is the rate at which an individual stock fluctuates in value relative to the market. Stocks with higher beta values fluctuate farther than the market, while low beta assets stick close to the market or even avoid fluctuation. In more recent years, smart beta has tried to combine different factors of risk determination to make more accurate measurements of the relationship between risk and returns. Included in these measures are those of behavioral finance, which uses psychological patterns in the market to estimate the relative risks associated with different assets. Malkiel ends the part with a discussion of risk parity funds, which use leveraging to increase risk on relatively low-risk assets to increase returns, and ESG funds, or environmental, social, and governance funds, which promise social responsibility in their investments.

In Part 4, Malkiel presents a complete guide to investing for readers of any stage of life. The basic advice Malkiel offers is to form the core of an investor’s portfolio in index funds, which attempt to mirror the entire market by investing in many stocks weighted to their share of the market. These index funds are low-risk, and they provide consistent returns over time by following the market. Malkiel advises readers to begin a rigid savings program immediately, investing regularly into index funds using a method called dollar-averaging, which avoids large fluctuations in the market. Younger investors are encouraged to invest more heavily in stocks to take advantage of the decrease in risk over time, while older investors are recommended to invest more heavily in bonds for more secure and timely returns. Though Malkiel does recommend investing in a variety of different funds and asset types, he makes it clear that many more risky investment products should be reserved for investors that have enough wealth to be comfortable accepting and maintaining higher levels of risk.

The Epilogue covers two criticisms of index funds: that index funds will make the market less efficient and that they will reduce competition through common ownership. Malkiel refutes both claims, noting that arbitrageurs always seem to maintain efficiency in the market and that common ownership, thus far, has supported increased competition in the market.