Book review of “A Random Walk Down Wall Street”

“A Random Walk Down Wall Street” is a long-running bestseller that promises to explain in lay terms how the security market works, and how to invest for retirement for maximum benefit. The book does deliver on its promise and is an enjoyable read. Read this review if you’re interested in what the book has to offer.

Malkiel’s book is often recommended on Internet threads when people seek or offer investing advice, and they recommend it for a good reason. On one hand, the author aims at conscientious, amateur investors, who might be inundated by well-meaning tips, or market rules, and provides clear investment guidelines: disregard most of the tricks and “wisdom” that you probably hear; you are often best off buying and holding broad-market securities and diversifying your assets. From this perspective, the rest of the book serves as a background and support for this advice, and I found it quite convincing at that ( although, always be careful about books that use anecdotes as their arguments). On the other hand, for those that are not curious about or do not believe Malkiel’s advice, it is also an exposition of main ideas that pervade the stock market and professional traders’ minds - technical analysis, behavioral finance, CAPM - and an interesting story of how these ideas play out in practice.

The book starts off with recapitulation of bigest market crashes. It’s always quite fun to hear about other people’s follies and downfalls. Malkiel focuses on the important themes of these crashes, their causes and effects, giving an occassional anecdote to punctuate a point. Like a story about a poor sailor who ended up in jail by eating a tulip bulb.

The main conclusion of these stories is that bubbles, and crashes are an inseparable part of a market. Despite advancements in knowledge, technology, and a lot of stake in the game - even modern age is subject to them. While some people may believe that they can reliably make significant, above-average gains, the author is doubtful that most such believers are correct. He espouses the Efficient-Market Hypothesis that claims that market prices are not predictable. They are effectively random - it’s impossible to consistently profit above the market. There are some good reasons to believe it. For one, the crashes are a good reminder of the market’s unpredictability. There’re also a numerous examples of how smart people couldn’t beat the market in the long term. Even the best funds in one age tend to underperform during the next one. While there may some caveats to market efficiency and unpredictability, it’s probably for the best not to rely on any special strategies. For example, a market prediction technique called technical analysis relies on analysis of past price movements to predict its future behaviour. The author goes to quite some lengths to argue why this just does not work. To quote Warren Buffet “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.”

So what remains? While many techniques are rubbish and do not stand the reality test. Some moderns developments do provide useful information. For example: Morowitz’ Modern Portfolio Theory and or Sharpe’s Capital Asset Pricing Model. They, basically, model assets on two basic parameters - expected return and risk (defined as variability, or potential to achieve extraordinary loss or profit). Probability theory can show that diversifying stock that is uncorrelated decreases risk, while maintaining expected returns. This strategy has its limits, but is a standard practice of investing. The mentioned theories are much more complex, of course, and the author explains some of their parts that are commonly mentioned in the environment.

After those three parts on how market works and how its participants think, we get to the promised part - what should we invest in. The message, which was summarized at the beginning of this article, is general and rather universal, though there are bits geared toward an American investor, like how to use IRA to optimize taxes.

In summary, the book paints the market as an untamed beast at first. But with proper diversification, long period of time, and common-sense the beast is manageable and useful. Or at least have been shown to be so historically. What future may bring, no one knows.