Podcast: Burton Malkiel and “A Random Walk Down Wall Street” 50 Years Later

85 total views

Episode 70 of the NewRetirement podcast is an interview with Burton Malkiel — a legendary American economist and author of A Random Walk Down Wall Street. Steve and Professor Malkiel discuss the latest edition of the book and some of the biggest lessons from Malkiel’s life.

Steve: Welcome to NewRetirement Podcast. Today we’re going to be talking with Professor Burton Malkiel, a professor of economics at Princeton University. As you might imagine, he’s got an incredible resume, including serving as a member of the Council of Economic Advisors, being president of the American Finance Association and Dean of the Yale School of Management.

He also spent 28 years as a director of the Vanguard Group. He currently serves as Chief Investment Officer to software-based financial advisor Wealthfront. We’re going to discuss Professor Malkiel’s book, a Random Walk Down Wall Street, and some of the biggest lessons from his life.

So with that Professor Malkiel, welcome to our show. We appreciate your time.

Malkiel: Thank you very much. Happy to be here.

Steve: So just to kind of get warmed up, I’d love to learn more about your story. I first saw you speak at the Bogleheads Conference a few months ago, and I was super impressed with what you had to say and kind of your worldview. I know you mentioned Japan and demographics and I want to touch on that later and how that might affect the world economy.

But as we get started, I saw that you’re a part of the army and I was wondering if you could give us a quick overview of why you joined the Army and went into business before you got your PhD in economics from Princeton in 1964.

Malkiel: Sure, sure. That’s fine. I grew up a poor kid in Roxbury section of Boston, a very poor section of Boston in a tournament house. And as a kid I was always good with numbers and I was kind of fascinated, even though I certainly was not investing, I had no money to invest. I was fascinated to how the numbers changed from day to day on the stock pages showing the stocks of the New York Stock Exchange.

And I kind of knew the price of General Motors each day about as well as I knew Ted Williams batting average. So I sort of had an interest in numbers and interest in the stock market from being a little kid. I then went to college and majored in economics and my advisors in college said, “You’ve got a pretty good flare for economics. You must go to graduate school in economics.”

And I would have none of it because the one thing that I was sure of growing up poor is that I did not want to be poor all my life. And so instead I went to business school. From business school. I actually had a stint as a finance officer in the Army Finance Corps putting in a computerized pay and accounting system and then went to Wall Street because being a poor academic was not what I wanted to be.

So I went to the investment firm of Smith Barney and Company, which is a now part of Morgan Stanley. I was an investment banker, but very interested in the research department of Smith Barney. They were known as having one of the best, if not the best research department on Wall Street. And I was just fascinated in getting to know how they operated.

And what interested me was that being a skeptic all my life, that I kind of wondered whether the emperor really had any clothes. These were very bright research people when they made suggestions of things to buy because Smith Barney had a big retail business, the price of the stock would go up maybe 5%, maybe 10%.

But then I noticed that it would fall back to where it was before and that the long run results of all of the fancy research recommendations were really not helpful at all, and that the people who acted on them and simply churned their portfolios around were simply subjecting themselves to transactions costs and to taxes if it was a situation where the whole market was going up.

So I kind of had this view of being a little bit suspicious about what paths for investment management and whether all of the fancy mutual funds that advertised as being the best things for individual investors really were. So as I’ve told you, I had been recommended to me that I go to graduate school.

I thought maybe that I would do graduate training at night at New York University, but while I was in the investment banking department, and it was a period of tremendous IPOs so that I would miss half my classes because I might be in Keokuk, Iowa rather than in class. And I realized that there was no way I was going to get a PhD degree on the side at New York University.

I had made a little money in Wall Street and I decided, “Okay, I will take a leave of absence. I will go…” And I was living in Princeton, New Jersey. “I’ll go get a PhD and then I will return to Wall Street,” which is what I expected. And in my PhD studies, I thought that I would actually look at data, look at empirical work and see whether my suspicions about what passed for investment advice and what passed for great research was really effective.

Basically just to put the end of this in view, after I got my PhD, much to my surprise, I was offered a job teaching at Princeton, and at the same time I was offered a job as a director of Credential Financial. And I thought to myself, I can perhaps be both an academic and a businessman at the same time in that the director’s fees from Prudential were extremely attractive. I was not going to be poor in any event, and I could do what I actually enjoyed was teaching and doing research on financial markets.

So that in a nutshell is my career and why I ended up basically as an academic, the board membership and Prudential basically morphed into board memberships in many other companies. I’ve probably been on a couple of dozen corporate boards through my career, and essentially it was a career of combining business, combining finance and getting in my view what was the right view about research and what was the right view about how people should invest.

Steve: Yeah, no, that’s a great story. It’s also awesome to get the historical context. I mean, we met, or at least I saw you at the Bogleheads Conference and I know you spent look 28 years with Vanguard. When did you meet Jack Bogle? And as you’re describing your story about you’re doing your own research of like, “Hey, is this individual stock picking and promoting working out doesn’t look like it’s working out.” Was there any benchmarking data being built, anyone looking at this closely at the time?

Malkiel: Yeah. The people who were probably doing the most empirical work were at the University of Chicago, and a fellow by the name of Jim Lori. Merrill Lynch actually gave the University of Chicago a research grant to present data on what were stock long run returns. And Lori and his compatriot Fisher, Lori and Fisher actually put together the first really good long run returns from the stock market.

And they started in 1926, they started a group at the University of Chicago called CRSP, which was the Center for Research in Security Prices. And they were the ones that put together the data. And as I looked at those data and then compared them with the long run returns from some of the best mutual funds, much to my surprise, I found, you know what, if you just looked at an index of the long run returns from the stock market in general, you did not only better than from the best mutual funds, but you did a great deal better.

And it was that, and actually a lot of very careful empirical work on all mutual fund returns that I did in the beginning of my academic career that made me view the fact that clearly the best thing for an investor to do would be to own simply an index fund. And I wrote a book during my early career at Princeton called a Random Walk Down Wall Street, and it was now 50 years ago.

And in that book I suggested that the best thing for an investor to do would be to buy a broad based index fund that essentially gave you the returns that Lori and Fisher had found in their study that was financed by Merrill Lynch. They suggested there were good long run returns from the stock market, which is why Merrill Lynch actually was delighted with the study, but in fact, not only did you not have to get professional portfolio management, but you could do it much easily by simply buying everything.

Now the book was, it was a commercial success, but the investment community hated it. And they hated it because number one, there were no index funds when I first wrote the book because it was first published in 1973, and the investment professionals hated it because they said, “Why would anyone want guaranteed mediocrity when we know that the hotshots in Wall Street can do better?”

So that was really where the whole thing started. In my career, we’re now at a period where I actually spent two years in Washington on the President’s Council of Economic Advisors working with Alan Greenspan, who’s a name that most people are quite aware of. And it was three years later that Jack Bogle started the first index fund. And the reception to Jack’s first index fund was really no better than the reception to my book in that Jack had an IPO and expected to sell 250 million of this first index fund to investors, and the investment bankers came back to him and said, “We better put it back to 150 million because I don’t think we can sell 250 million.”

Jack said, “Okay. “The investment bankers went through, they did the roadshows, and when the final results were tabulated, 11 million were invested in the first index fund. And the index fund was thought of as a Jack Bogle’s folley, and it was very small for some considerable period of time.

But then I left Washington at the beginning of 1977 and Jack asked me to join the Vanguard board, and we then started a wonderful 28 year relationship.

Steve: And have gotten proven right over the subsequent 50 years.

Malkiel: No, absolutely. Jack and I actually used to joke with each other that he and I were the only investors in the first index. But eventually people did get the clue and eventually the wonderful thing is that people finally react to the evidence. And the evidence is just so clear. As I’ve looked at what I said in my random workbook 50 years ago, I am more convinced than ever that Jack advice was absolutely right.

Standard & Poor’s does a study actually twice a year. It’s called the SPIVA Study, and that stands for Standard & Poor’s Indices Versus Active. And every year, I’ve been doing this now for decades, every year you find that in a single year about two-thirds of active managers are beaten by the index. And the problem is the one-third that win in one year aren’t the same one-third that win in the next year.

So that when you compound this over five and 10 and 20 years, you find that then 90% of active managers are beaten by the index. Now, I’m not saying it’s impossible to beat the index, but it’s like looking for a needle in a haystack.

And for the average investor, if in fact you try to go active, yep, there’s a chance that you might do better than the index, but there’s a 90% chance that you’ll do worse, and on average you do about one percentage point worse. And boy, that deficit compounds over time. And there’s simply no question in my mind that the average investor is much better to simply buy and hold a broad based index fund.

Steve: Yeah. What do you think happens… Is there a limit that you see if so? I totally agree. I think recently Vanguard Passive has been taking in a billion dollars or was it billion dollars a day or something like that of money flowing that way. But is there an upper limit? Because I do think you need… As an entrepreneur, I take concentrated risk with my human capital.

We’re making big bets and saying, I recognize it’s highly risky that this completely fails, but there is a certain amount of innovation that’s require and risk taking. And how do you think that should get represented across the whole economy?

Malkiel: Well, let me first of all answer your first question. Is there too much indexing? And my sense is there’s too little that now index funds are half of mutual funds and there are the exchange traded funds, so maybe half of the money that’s invested is indexed, and I think it’s too little.

Now, you point out a real paradox that in fact, you need some active managers in order to make sure that the market is reasonably efficient. You need active managers to make sure that in fact, information gets reflected in prices. So yes, you need them, but we could have 99% of the market indexed and there would still be the kind of entrepreneurs that you’re talking about that still would be willing to go and be active.

And in fact, you are still going to have the citadels of the world that act on information, and they might get it a millisecond before other people and make money doing it. They do make money, and it’s what’s called picking up pennies in a front of steamrollers. You do need them. We will still get them, even if 99% of the market is indexed.

Steve: Do you think that we’re… What do you think the world looks like in another 10 or 20 years? Do you think this trend is going to continue? We’re going to get a lot more people saying, okay, I see the data, many more folks will be indexing and then there’ll be a small slice of people doing innovation and price discovery and active investing.

Malkiel: Well, I hope so. And I hope my book will still be read 50 years from now, and that its influence in making people more aware of the benefits of index investing and making people in their retirement accounts and their 401(k)s and their Roth IRAs invest in a diversified set of index funds. I am hoping very much that that will continue and that indexing will grow.

But look, suppose 100% of people were indexed, you can’t believe that there’s some entrepreneur, if there is some inefficiency that’s around and the market’s not ever going to be perfectly efficient, you can’t believe that people like you won’t be around to make sure that if there is something that is missing in the market that it will be corrected.

Steve: Right. Yeah, I think it’s interesting. You can’t take the animal spirits, the emotional side of this away from people.

Malkiel: And you never will. And you never will.

Steve: I saw that you have an interest in casino betting and horse racing, applying statistics to those spaces. A good friend of mine, I was playing online poker with him last night, and he’s an MIT guy and he’s very quantitatively smart, but he always had these theories about how you could beat the market and stuff like that.

And it’s interesting watching people do this stuff. How do you square those interests with your database view of the market?

Malkiel: Look, I sometimes buy individual stocks, and I clearly have a gambling instinct. I enjoy going to the horse races. I would not miss the Kentucky Derby on television. I have bet on the Kentucky Derby. I enjoy doing it. It’s fun, and buying some individual stocks is fun, but I can do it with less risk because my step IRA, all my retirement funds are safely indexed and I don’t object to people buying individual stocks, but what my advice is that the core of any portfolio ought to be indexed.

Then if you want to have fun around the edges, that’s fine. And if you feel very strongly about renewable energy and you feel good about buying a company that makes wind towers, go ahead and do it. But do it only if the core of your portfolio is broadly indexed.

Steve: Yep. Yeah, 100% agree. And for most folks is that, I mean, guess it depends. I think when we think about the world and people’s plans, we want to make sure that they have enough money to maintain their quality of life. Once they get over that threshold, then they can start taking increasing amounts of risk. So it varies by person.

And I do think that the risk profiling is getting a lot more sophisticated because when you look at individuals, there’s the financial ability that you have to take risk. Then there’s the emotional ability like can you deal with it if the market moves up and down. And very often people don’t think about these things separately.

And then the last bit is how much risk you actually need to take. Because if everything’s all said, if you have pensions that guarantee your income for life and social security, then maybe you don’t need to take any risk. It’s only if you want to.

Malkiel: But for the people of modest means. And in fact one of the things that it probably pleases me most about the book is that it encourages people with very little means no assets to just start investing if it’s nothing but a few dollars a week. And I’ve got a chart in the book that says, what would’ve happened if you did what I am suggesting at the beginning of the period when index funds were available.

And there’s a chart that shows $100 a month, this is a little over $20 a week. This is going to Starbucks a couple of times during the week or doing streaming rather than going out to the movies. What if you could put $100 a month into the total stock market index fund? This is the index fund that I recommend.

And it’s just amazing that we’re now talking about if you did that over the period from when index funds were first available, the amount of money you would have now is about one and a half million dollars.

So the fact that you can actually do it really places me. And what probably places me even more is that this isn’t just a hypothetical that people write me and people send me letters and say, “I’ve done what you suggested all of my life. I’ve never been wealthy. I’ve never had more than the most modest salary, but now I am retired and comfortably retired.”

And boy, there is just nothing more pleasing to me than to think that in fact, something one has done has in fact significantly improved the life of the people who have read my book.

Steve: Yeah, no, it’s incredible. And I think that’s a great legacy to have affected millions of people’s lives that way. It’s interesting, one of the sayings, it’s time in the market, not timing the market. And unfortunately, we spend so much time educating people about how to make the most of your human capital develop skills, you can go and make money, and then everybody thinks about their income from work.

Most people don’t trained and fully appreciate that you need to make your money work for you. And the best way to do that is to invest it. And the best way to invest is to broadly buy essentially the US stock market or the world stock market and just capture the effort of everybody else that’s working and the returns that accrue to that market and keep doing it for long periods of time and don’t shoot yourself in the foot by trading it now selling when things get bad, you got to keep buying all the way through.

And our audience is actually full of people that are like this, where they’re kind of 401(k) millionaires, they’ve been working and saving, and they got the message and they did it. Unfortunately, that’s only 5% of the population or something like that right now.

Malkiel: Well, but that’s exactly the point of your point about time in the market and not timing. One of the things that I’ve certainly stressed that in the book and showed that it’s simply impossible to get it right. The idea of the book’s title, a Random Walk Down Wall Street is, let’s face it, nobody but nobody, professionals, amateurs, nobody is going to be able to consistently predict what’s going to happen in the market.

You can get it right every once in a while, but if you keep doing this, you’re going to lose. You are not going to have a good long run performance, and particularly in times like this, where the markets have been to 2022 has not been a great year in the market.

But if you think you’re going to be able to get out and then get back in at the bottom, don’t even think it, you won’t do it. It’ll be one of the biggest mistakes that you could possibly make.

Steve: Yeah. Now it’s interesting. Do you know or ever heard of Jail Collins? He wrote a simple path to wealth. So anyway, it’s similar thinking, right? He basically, he tries to simplify this boil down the lessons that we’re talking about, which is invest. He recommends buy VTS.AX if you’re going to just buy this thing and just put your money in it.

I was talking with him a few years ago and I had some cash and I was like, “Well, should I dollar cost average in or should I just put it?” And he’s like, “Just put it in the market. Don’t even think about where you’re at and try to time anything. Just dump it in and just forget about it.”

Malkiel: But that’s the point. That actually then points out another very important lesson, and that is the dollar cost averaging lesson. The beauty of the dollar cost averaging, which means that if you invest regularly like that, $100 a month that I had suggested, sure there’ll be periods like 2022 when the market goes down.

There’ll be periods like 1987. But the nice thing about it is that that $100 buys more shares of your broad-based index fund when the market is down. And even in a period when the market has done nothing, you can make money by dollar cost averaging.

For example, if you look at the period from 2000 to 2010. January, 2000 was about the peak of the .com bubble. The market went down sharply. The market was terrible during the first decade. It was often called the lost decade. But if you dollar cost averaged during that decade, just put your money in $100 a month and you reinvested all your dividends, you made almost 6% even in years when the market did nothing.

And that is just so important. You’ll never time it right. If you just dollar cost average, you’re going to have absolutely the best investment results. It’s unusual that the best advice is the simplest advice, but it’s really true in investing.

Steve: Yeah, no, it’s true. Give it as simple as possible. So let’s shift to your book, a Random Walk Down Wall Street. So you originally published this 50 years ago, which is incredible and I’ve heard about it the whole time I’ve worked in personal finance. It’s very often the first book that people suggest folks read.

So simple question, how many copies have been sold so far? 2,000,000? Wow, that’s incredible. That’s a lot of lives. And what’s different between the 50th anniversary edition and what’s the same?

Malkiel: Well, it’s an investment guide and well, the message is the same. What’s different is that all of the investment vehicles that are available to people are totally different than they were when the book was first published. As I mentioned, one of the criticisms of the book when it was first published is you can’t buy the index. And I said in the first edition, it’s about time that you could, and I encouraged people to start selling index funds.

So index funds didn’t exist. Exchange traded funds didn’t exist. We didn’t have money market funds, we didn’t have municipal bond funds, we did not have 401(k)s, we didn’t have Roth IRAs, we didn’t have 529 college savings plans. So what’s different is to be able to actually do practically what was suggested in what was an a optimal investment strategy.

The vehicles that you have now to do it are just totally different. So that’s one change. Another change is to look at the evidence that’s accumulated over time, and that’s what has gone into every new edition. And that makes me feel that the advice in the original edition was not only right but it was even better than I had anticipated is. If anything, I believe in it even more strongly.

But also what I’ve done in the new additions is there’s a lot of stuff that’s popular now. And so I have a new section, for example, in the 50th anniversary edition on ESG investing that is investing in funds that purport to be environmentally friendly and socially good and with companies that have good governance. And I ask whether that’s a good substitute for the broad-based index funds that I suggest.

And I will tell you that my conclusion is that if you buy a broad-based ESG fund, you may neither be doing things that are socially useful, nor are you going to get better returns. If you feel strongly about certain things that you want to invest in, as I suggested earlier, like wind power or a solar panel company, fine, but do it as an add-on to a broad-based index fund.

Don’t do it in an expensive ESG fund because you will neither do good for humanity nor do well financially. And don’t believe the hype that the ESG funds are suggesting. So that would be another example of something that’s new and something that I think is very useful for investors, even investors who quite reasonably would like their money to have good results.

Steve: Right. Yeah, it was interesting being at the Bogleheads Conference and everybody was thinking the same way that hey, ESG is really not efficient and not that great. And it’s also interesting, my view on ESG is like, hey, it was a ground movement where millennials and Gen Z were like, “Okay, hey, we want this.”

It was initially good and then it feels like Wall Street got its hands on. It was like, actually no, we’re going to have a lot of this stuff and let’s dress up our investments with ESG and use it as a marketing tool. And now it’s getting pushed in a big way to the broader investing public. And it’s actually like you’re saying, not that efficient.

Malkiel: And what’s happened is there’s something that’s called greenwashing that there are funds that had nothing to do with ESG, but they’re being advertised as if they really are ESG funds and they really are contributing to the social goods. So you got to be very careful. Wall Street is very good at marketing and being… I told you at the beginning, I started my career just being a skeptic, and I think it was May West who said, “If you think you’re too skeptical, don’t believe it. There’s no way you can be skeptical enough.”

Steve: That’s funny. All right, well I think this is a good way to, let’s pivot to another question here. I want to talk about something in your book, the Firm Foundation theory and Intrinsic Value, and then also have you kind of talk about bubbles and what you think about crypto coins, not necessarily DeFi, but what do you think about what’s happening recently with these developments where so much capital is going into crypto and where do you think that might go?

Malkiel: Well, let’s do crypto after. And let me get the first part of your question. The idea of what I had actually called the Firm Foundation theory, or really this is a kind of graham and view of what is the right value of a stock and the right value is the present value of its cash flows and every stock has a good intrinsic value, and that in fact, that’s the hallmark of markets.

Well, it doesn’t work exactly well. People are pretty good that in making stocks reasonably efficiently valued, and in most cases, stocks are a good reflection of their long run values. But we do have bubbles. We do have people getting, particularly with new technologies, we had this in the .com era.

And there’s no question that at periods like that, there was no way that stocks reflected intrinsic value. I mean, you get the situation in the late 1990s where people would put .com after the corporate name and the stock would go up 20%. I mean, it was absolutely crazy. So people then say, okay… So many people say to me, “Okay, Burt, now you say you’re not supposed to go and buy and sell,” but everybody knew that this was absolutely crazy.

Why didn’t you go and sell them and avoid the big decline that happened in the early 2000s? Well, I point out that this was a bubble. I agree that it reflected non efficiency, but I also suggested that no one can tell when the bubble is going to pop, how high the bubble is going to go and when to get back in.

And I like to point out to people that it was Alan Greenspan who actually coined the expression irrational exuberance, and he’s credited with… He said it was a bubble. Why didn’t you just go out when he said it was a bubble?

Well, he said it was a bubble in 1996. The bubble culminated in February of 2000. And in fact, if you had bought the day after Alan Greenspan’s speech, you would’ve done extraordinarily well in the market. So the problem is not that the markets are perfect, they are not.

The markets may be always wrong, but nobody knows when they’re too high or too low. Nobody can tell how strong the bubble is going to be and when it is going to end. This happened with meme stocks. You had this GameStop and the Reddit mob internet, mob made it go up 10% one day, and then 20% the next day it got absolutely crazy.

They were selling in stores games that were now being distributed online. It was a crazy idea. There was no intrinsic value there. So a hedge fund, Melvin Capital decided, “Okay, we’ll bet against it. This is a clear case of a crazy market.” So what happened? They went bankrupt. Eventually GameStop fell down to Earth as did AMC theaters.

So again, I’m not saying that the market doesn’t go crazy. What I am saying is you’ll never know when the top is. You’ll never know how long these things are going to last, and please don’t just continue to try to get it. Let me mention another thing, and again, it was in the recent crazy market.

People criticized me a couple of years ago and said, “You’re crazy. Why would anyone want to buy an index fund when I can buy a Cathie Wood Fund and it’s going up twice as much or three times as much as an index fund?” Well, if you had bought that Cathie Wood Fund, you wouldn’t be very happy today because what happens is these things eventually fall down to earth as all of these bubbles do.

So yes, there are bubbles, but don’t think that you can ever find the top buy and sell. If you could, it would be wonderful, but you can’t do it. And so please just keep your $100 a month or whatever it is, invest it in broad-based index funds, buy and hold and don’t get tempted even when you are sure the market has gone crazy. And it does go crazy from time to time.

Steve: I think it’s interesting. It’s also somewhat it changes your risk. Appetite changes with time. So you see a lot of young people, especially young males, they’ll be like, they think they can beat the market. They want to get rich quickly. I think their sense of time is different than people who are a little bit older.

And they’ll take these, they’ll jump in and do these meme stocks and do crypto and take crazy risks because they’re like, “Well, this is silly, right? Why would I take 20 years to get rich when, yeah, I can get rich overnight.” And it seems faster investor, but-

Malkiel: Okay, so let’s talk crypto. Crypto is something that a lot of people say, “Look, this is the future. This is what we want to do.” And I am, as you might expect, skeptic about crypto. Crypto is… I don’t think it is… I wouldn’t go as far as Warren Buffett and saying the value of crypto is zero. It’s totally worthless. It is a currency, it’s accepted.

But who would want a currency where if you go and buy your coffee in the morning, it would cost a certain amount in crypto and 10% more or 30% less the next day. So it’s not useful as a currency because it fluctuates so much. Now where it is useful, and I will admit crypto has its uses, it is anonymous and it is much harder to trace.

And if I wanted to buy some drugs from you, I’d probably be delighted to use crypto to pay for it. And that is its use. But exactly the good use for crypto is why I don’t think it’s ever going to be a long run answer because governments aren’t going to allow this to happen.

Look, there will be will certainly improvements in our payments mechanism. There will certainly be improvements in our international payments mechanism. I wouldn’t be a bit surprised if we have a crypto dollar at some point, but crypto, but bitcoin, which can go from almost 70,000 to 16,000, which it is now is not the answer.

And I would advise people to stay away from crypto if you insist on doing it. Again, don’t do it with your serious money. If you want to go and gamble, fine. But I’d much prefer you gambled on individual stocks because the stock market is a gambling casino where at least the long run is positive. I don’t think it is for Bitcoin or any of the other cryptocurrencies.

Steve: Yeah, no, it’s interesting watching this whole thing unfold and it feels like, especially with what’s happened with FTX, a lot of people have checked out now and they’re like, “All right, well who knows what is actually happening behind the scenes at all these companies?” And they’re just blowing up, these exchanges are blowing up and some of the coins are going away completely.

And do you want to be putting your hard-earned savings in vehicles like that when it could go to zero? It does feel like sometimes generations have to learn these lessons themselves. You might say, “Hey, South Sea China Bubble, hey, tool mania, this stuff has happened .com stocks.”

And then another generation comes along and they’re like, “Whatever, here’s a new thing and I’m going to make a fortune and in a year doing this.” And then they get punished and then they learn their lessons and then eventually become index investors over time.

Yeah. All right. Awesome. So on that note, actually, I’m curious what you think about Robinhood. So Robinhood’s doing something interesting, right? It’s got a lot of investors engaged. They have made it dead simple to buy mostly individual stocks. So it’s kind of like it’s doing a good thing by making it simple and getting people exposed to investing, but it’s doing, I don’t know if it’s necessarily great in terms of, hey, here’s some of the good habits. What do you think about a company like that?

Malkiel: Well, I worry about Robinhood because I think it really is a site that encourages gambling rather than investing. They’ve taken it down, but as it started, one of the things Robinhood did was if you bought a stock at 50 and sold it at 55, so you had a good trade, you would have a home run in a baseball game where the scoreboard shows you fireworks. It would congratulate you and show you the fireworks.

And so the whole way the site was set up in my view, was set up to encourage gambling as opposed to investing. I mean, my view is you buy and hold to the extent you buy a stock, you buy and exchange traded broad-based index fund, you don’t trade it. And I think it’s wonderful now that we are able to have people buy with zero commissions and that we have the Schwabs and the E-Trades of the world available for people to trade with no commissions.

But I just worry about the brokers like Robinhood, who I believe are just almost encouraging, not almost who are encouraging gambling.

Steve: Yeah, unfortunately doing well on the market is very often boring if you do the right things. It’s like buy, keep buying, buy index funds, keep doing it for long periods of time, don’t worry about it. Don’t think about it too much.

Malkiel: Fun. Then take a little extra mad. I even like Jim Cramer. If you want to go… And Jim Cramer has come around finally to say that index funds are good and do what he suggests with your Mad Money. As I told you at the beginning, I like gambling. Gambling is fun. Fine, take a little money and use it as your fund money, but don’t do it with your serious money. Your serious money should be boring.

Steve: Yeah, that’s awesome. All right, well look, this has been great. As we wrap up, any suggestions for books in addition to a Random Walk Down Wall Street that you think folks should read or resources that you like for the individual investor to get educated and make good decisions?

Malkiel: There are certainly other books that have the same view. One of the books that I’m particularly fond of, although it’s not an investment guide, is Charlie Ellis’s book, Winning the Loser’s Game. And what I particularly like about this is there’s just a terrific analogy that I think just kind of brings the right advice home.

And it’s about a tennis game and Charlie says, “If you’re a professional tennis player, it’s that blistering serve, it’s that incredible drop shot that wins tournaments. But if you’re an amateur or just a regular tennis player, the people who win are not the people who do the fancy shots. It’s simply the people who put the ball back in play and wait for your opponent to make a mistake.” And I think that’s just absolutely wonderful. It’s actually one of my favorite investment books.

And Charlie writes very well and he got a new addition of it. So that would be one that I would recommend for people.

Steve: We’ll definitely link to that in addition to your book. And then just last question. I mean, so 50 years since Random Walk Down Wall Street came out and we talked about all the changes you’ve seen, the developments in the investment products and the education that’s happened and people kind of tilting towards indexing and a lot of the tax efficiencies that are out there.

As you look forward, any giant predictions about how you think the world might be different in way 20, 30 years in the future given what you’ve seen the trajectory of services?

Malkiel: Well, one of the things that you might say, this is perhaps a little twist on indexing that I spend a lot of time on in the new edition, and it is an innovation that I think is really important and that is what’s called direct indexing. The outperformance is called gaining an alpha because the empirical work that looks as to whether people can beat the market want to do it, risk adjusted and outperformance is then measured by this alpha.

The only sure way that I know of gaining an alpha is by tax management. And the way direct index name works is suppose let’s talk about it with the S&P 500. Instead of buying all 500 stocks, let’s buy only 250 of them chosen so that they have the same industry composition and the same size, the same volatility. And we’ll use a computer to optimize so that they will track the index with about minimum variation.

Then what we’ll do is if the drug companies are down, we will take a tax loss on Pfizer and buy Merck. If the autos are down, we’ll sell General Motors and by Ford. In other words, we’ll be indexed, but we will gain all of the tax losses which are tax deductible. And so pre-tax, not getting an alpha, but you get an after tax alpha.

And I think this is a very sensible thing to do. It’s something that we do at Wealthfront, which you had mentioned where I’m the chief investment officer, we’re indexers, but we are direct indexers. And I think you’re going to see a lot more of that.

And to the extent that I look to people to be indexers, to the extent that I see changes in the future, I think you’re going to see a lot more direct indexing than simply buying an index fund.

Steve: Yeah, we saw a recent flurry of activity. I actually met… Do you know Patrick Geddes from Aperio? I think they sold their firm to-

Malkiel: I know Aperio very well. They and Parametric are the two companies that do a lot of this tax management for institutional investors.

Steve: Yeah, I met the folks from Aperio, they live in Mill Valley, so I haven’t met them. Actually, Paul Solli, who was one of the founders, was here yesterday talking about an education focused business that he was interested. I might have him on the podcast. We can go deeper on direct indexing.

All right, well look, Professor Malkiel, I really appreciate your time. This has been incredible. So thanks for being on our show. And for folks that are listening, hopefully you found this useful and you can check out Professor Malkiel’s book, A Random Walk Down Wall Street. We’ll include a link.

Malkiel: 50th anniversary edition will be published January 3rd, 2023.

Steve: All right, only a little bit more than a week away, so cool. If anyone needs help with planning, you can check out what we’re doing at We also have a Facebook group that you can join other folks who are actively thinking about financial planning and thinking strategically about it. And then finally, we’re trying to build the audience for this podcast. So if you liked it, any reviews are welcome or any sharing is super welcome as well.

So again, thank you very much for being on the show and hope to talk to you again soon.

Malkiel: Okay. Thank you very much for your excellent questions. I appreciate it.

Steve: It was an honor to have you on here.

Malkiel: Thank you.

Share this Post