At Justwealth, we expend a lot of energy and produce a lot of communication materials that focuses on educating investors about some of the troubling aspects of investing their hard-earned money. Outrageous fees (quite often hidden), conflicts of interest, poor service, and deceptive sales practices are just a few of the things that have given the financial industry a bad name. If you want to read a book that goes into greater detail on these and many more issues, then you must read “A Random Walk Down Wall Street” by Burton Malkiel.
Burton Malkiel is an economist at Princeton University, who published his first edition of the book in 1973. The book is now up to its 11th edition and continues to remain relevant. In 2012, Malkiel was named Chief Investment Officer of Wealthfront, one of the largest online financial advisors (a.k.a. robo-advisor) in the United States. The book is U.S.-centric, but the facts and issues are no different in Canada, hence the reference to Yonge Street in our title (which also happens to be the street where Justwealth is located!).
Much of the content of the book is referenced to academic research in the field of finance, so it might not provide you with a lot of great stories to tell at cocktail parties. But the good thing about most academic research is that it tends to be unbiased, in complete contrast to marketing material (often disguised as “research”) prepared by wealthy financial institutions.
A “random walk” is a statistical reference that essentially states that you are unable to predict future events based on the results of similar past events. Flipping a coin would be an example of an event that exhibits a random walk since the outcome of any previous coin flip has no bearing on the outcome of any future coin flip. Translating the concept in investing terms, one could say that you are unable to predict future stock prices based on historical stock price movement (particularly in the short run). Taking the translation one step further, the ultimate conclusion of the book is that no one can consistently outperform the market, or in other words, active management does not work.
Some of the other interesting key findings of the book include:
- There are two main forms of research methods used by professional investors to try to beat the market: Technical Analysis and Fundamental Analysis. Neither form works.
- Much of the “research” recommendations produced by professional analysts are tainted by conflicts of interest, and their performance has been found to be well below market returns. Sadly, these recommendations typically flow through to client-facing financial representatives who implement the recommendations in unsuspecting client accounts.
- It is not possible to pick winning mutual funds. Over time, mutual funds tend to converge to “average” performance, minus LARGE fees. If it is not possible to pick winning stocks, why should it be possible to pick winning mutual funds?
- Markets can be irrational, and bubbles can form – but you cannot profit from it! A good quote from economist John Maynard Keynes: “Markets can remain irrational longer than you can remain solvent.”
- Despite overwhelming evidence that active management does not work, investors continue making mistakes with their investments. These mistakes happen because investors are human and do not always act rationally. Many of the flaws can be explained by the emerging field of Behavioural Finance…something that we at Justwealth follow closely.
The findings and conclusions put forth in the book are not popular with individuals and corporations who make their living selling and promoting expensive actively-managed products or services. Needless to say, you will never find this book mentioned or referenced in Canada at a bank or a mutual fund company because it’s bad for business. We, however, consider this book to be a proof statement that validates much of what we do for our clients:
- Invest with the long term in mind
- Diversify wisely using strategic asset allocation
- Invest systematically, not based on emotion
- Keep costs low
Invest with the intention of being considered smart later rather than trying to outsmart the market now.
Written by James Gauthier, Chief Investment Officer at Justwealth
James is an experienced portfolio manager and asset allocation specialist who has devised some of the most innovative and sophisticated asset allocation policies for institutions, high net worth clients, and large wrap programs over the past 20 years. James has previously been responsible for the management of billions of dollars of client assets on behalf of large financial institutions in Canada. James obtained his education from McMaster University where he earned a Bachelor of Science in Mathematics and an MBA in Finance.