Burton Malkiel on the 10th edition of "A Random Walk...

[BruceM]

Brent Hunsburger of the Oregonian conducted a recent interview with Burton Malkiel on his latest (10th) edition of his cornerstone publication, "A Random Walk Down Wall Street", which became the basis for passive investing.

http://blog.oregonlive.com/finance/2010 ... l_bul.html

There are some real quotables in this interview....my favorite is

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance. I like to quote my friend (and Vanguard Chairman) Jack Bogle, "This is a game where you get what you don't pay for."

BruceM

[#Cruncher]

Reading an earlier edition of "Random Walk..." is what got me into passive investing in the first place. And I'm still interested in what Malkiel has to say. One quote from the interview I'll be pondering...

I've always suggested that people need to be widely diversified. What I've done more of in the 10th edition is stress the need of international diversification and, in particular, the need to be in emerging markets. I didn't mention China in earlier editions. China's now probably responsible for something over 10 percent, maybe even 13 percent, of the world's GDP. It's the fastest-growing economy in the world, and most investors have little, if anything, invested in China.

[nisiprius]

[Brent Hunsberger:] Do you subscribe to the idea that investors should invest their age in bonds?

[Burton Malkiel:] No, I think that's too conservative. I actually changed my bond allocations in the 10th edition. I added about 5 percent to equities and took them away from bonds because, look, people are living longer.

I am sorry to hear this facile rationalization coming from the mouth of Burton Malkiel.

Source of data: http://www.cdc.gov/nchs/data/hus/hus200 ... ble024.pdf
The CDC website doesn't seem to have anything more recent than 2007



Life expectancy at age 65 increased by a total of 2.2 years over the 27-year period shown.

That's a rate of less than one month per year.

I do not think that a 5-year improvement has been achieved since the last edition of A Random Walk Down Wall Street, four years ago.

If "age in bonds" was appropriate in 2007, and if life expectancy is the rational for changing it, then "age - 4 months" would be appropriate today... a shift of 0.3% from bonds to equities, not 5%.

[dumbmoney]

Burton Malkiel is employed by AlphaShares, which sells China-related investments. So you may want to take his comments about China with a pinch of salt.

[letsgobobby]

this obsession with China strikes me odd. We know it's fastest-growing. Aren't its shares also most-expensive? Doesn't that matter to anyone any more? Didn't Jeremy Siegal among others convincingly demonstrate that you go where the value is, not where the growth is?

[stratton]

this obsession with China strikes me odd. We know it's fastest-growing. Aren't its shares also most-expensive? Doesn't that matter to anyone any more? Didn't Jeremy Siegal among others convincingly demonstrate that you go where the value is, not where the growth is?

He's had his China obsession since at least 1997 in this book:

Global Bargain Hunting: The Investor's Guide to Profits in Emerging Markets

The publication data is July 1999, but it doesn't even have the 1998 EM dump in it. All data ends in late 1997. A typical EM allocation for him in this book is:

60% Vanguard EM fund.
20% China via CEF
20% Eastern Europe CEF

A lot more bonkers about China in this book:

From Wall Street to the Great Wall: How Investors Can Profit from China's Booming Economy

The hardback came out in 2005. A typical China asset allocation isn't just China, but Hong Kong and surrounding countries China trades with:

25% China
25% Hong Kong
50% Vanguard Pacific

There are even more complicated ones for $100K investments for "China" where there is energy and gold. In all cases only 25% is actually in China and 25% in Hong Kong.

Paul

[Taylor Larimore]

Hi Bruce:

There are some real quotables in this interview....my favorite is

"The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance. I like to quote my friend (and Vanguard Chairman) Jack Bogle, "This is a game where you get what you don't pay for."

In my opinion, Professor Burton Malkiel's Random Walk Down Wall Street is one of the best books ever written for ordinary investors to understand how markets work.

Below are more "quotables" from his book:

"A random walk is one in which future steps or directions cannot be predicted on the basis of past actions."

"On Wall Street, the term 'random walk' is an obscenity."

"I wrote (in the first edition) that a blindfolded chimpanzee throwing darts at the Wall Street Journal could select a portfolio that would do as well as the experts."

"Through the past thirty years--more than two-thirds of professional portfolio managers have been outperformed by the unmanaged S&P 500 Index."

"All too many investors are lazy and careless--a terrifying combination when greed gets control of the market and everyone wants to cash in on the latest craze or fad."

"It is not really hard to make money in the market."

"With index funds, you know exactly what you are getting, and the investment process is made incredibly simple."

"The most important decision you will probably ever make concerns the balancing of asset categories (stocks, bonds, real estate, money-market securities, etc.) at different stages of your life."

"According to Roger Ibbotson, more than 90% of an investor's total return is determined by the asset categories that are selected and their overall proportional representation."

"Securities analysts always find reasons to be bullish."

"In the 1990s, the ratio of buy to sell recommendations climbed to 100 to 1, particularly by brokerage firms with large investment banking businesses."

"Stock investors can do no better than simply buying and holding a fund that owns a representative sample of all the stocks in the market."

"I am convinced that no one will be successful in using technical methods to get above-average returns in the stock market."

"Simply buying and holding a diversified portfolio suited to your objectives will enable you to save on investment expense, brokerage charges, and taxes."

"Every investor must decide the trade-off he or she is willing to make between eating well and sleeping well."

"Again and again yesterday's star fund has proven to be today's disaster."

"The laws of chance do operate and they can explain some amazing success stories."

"It turns out that the portfolio with the least risk (1970-2002) had 24% foreign securities and 76% U.S. securities."

"What worked in the past does not necessarily work in the future."

"I strongly suggest you invest some of your assets in REITs."

"TIPS are great portfolio diversifiers."

"The current inventory of gold is some 50 times its annual industrial requirement--."

"Beta, as it is usually measured, is not a substitute for brains--."

"There is never going to be a handsome genie who will appear and solve all our investment problems."

"Buying and holding a broad-based market index fund is still the only game in town."

"Any truly repetitive and exploitable pattern that can be discovered in the stock market and can be arbitraged away will self-destruct."

"Given enough time and massaging of data series, it is possible to tease almost any pattern out of most data sets."

"Clearly, buying a portfolio of small firms is hardly a surefire technique to enable an investor to earn abnormally high, risk-adjusted returns."

"Over a period running back to the 1930s, it does not appear that investors could actually have realized higher rates of return from mutual funds specializing in 'value' stocks."

"I am convinced that many studies have been flawed by the phenomenon of 'survivorship bias.'"

"The more profitable any return predictability appears to be, the less likely it is to survive."

"I have yet to see any compelling evidence that past stock prices can be used to predict future stock prices."

"Never buy anything from someone who is out of breath."

"The decision of which IRA is best for you and whether to convert can be a tough call."

"For investors who are very risk averse, I favor GNMA funds."

"Own your own home if you can possibly afford it."

"I would also steer clear of 'hedge funds.'"

"The investor who's wise diversifies."

"If your expected investment period is only for a decade or less, no one can predict the returns you will receive with any degree of accuracy."

"Don't invest with a rear-view mirror."

"'There ain't no such thing as a free lunch.' Higher risk is the price one pays for more generous returns."

"Switching your investment around in a futile attempt to time the market will only involve extra commissions for your broker, extra taxes for the government, and poorer net performance."

"Dollar-cost averaging can reduce the risks of investing in stocks and bonds."

"Don't think that dollar-cost-averaging will solve all of your problems."

"What goes down must come back up. But this does not necessarily hold for individual stocks, just for the market in general."

"The key to whether any recommended asset allocation works for you is whether you are able to sleep at night."

"For most people, I recommend broad-based total stock market index funds rather than individual stocks for portfolio formation."

"Taxes are a crucially important financial consideration."

"I have become increasingly convinced that the past records of mutual-fund managers are esentially worthless in predicting future success."

"Luck may be 99 percent responsible for the success of the very few peole who have beaten the averages."

"The mutual fund industry has developed a system of charging expenses to investors that is as complicated as IRS income tax regulations and equally unpleasant."

"I have often said that the two best things that have happened to the mutual fund industry are the arrival of Jack Bogle (of Vanguard) and Don Phillips (of Morningstar)."

More Quotables: Investment Gems

[Adrian Nenu]

Since Malkiel doesn't understand the importance of risk of loss when determining portfolio suitability, I am not surprised that many other investors and advisors to get it either.

Adrian
anenu@tampabay.rr.com

[Taylor Larimore]

Since Malkiel doesn't understand the importance of risk of loss when determining portfolio suitability, I am not surprised that many other investors and advisors to get it either.

Adrian
anenu@tampabay.rr.com

Hi Adrian:

Have you read Professor Malkiel's book? If so, I doubt you would make the above statement. In the book's "Index" under "Risk" these are the sub-headings:

Assumption of
Attitude toward
Beta as measurement of
Bonds
Capacity for
Of Common stocks
Defined
As dispersion of returns
Financial survival as factor in
Of growth stocks
International scene
Loss aversion
Measurement of
Modeling of
Of mutual funds
In new investment technology
Portfolio diversification
Premiums
Psychological makeup as factor in
Of real estate investment
Rebalancing
Reduction of
Of savings accounts
Of six-month certificagtes
Sleeping scale on
Staying power
Systematic
total
Of Treasury securities
Unsystematic

Mr. Malkiel spent 26 years as a Vanguard Director. This is his partial Biography:

http://en.wikipedia.org/wiki/Burton_Malkiel

In my opinion, Professor Malkiel understands "risk" very well.

[Adrian Nenu]

Taylor, I haven't seen portfolio risk of loss as a determinant of suitability in any of the recommended books, including Malkiel's. It's is a serious deficiency in my opinion.

BTW, I read Malkiel's book back in 1988 and just about every new edition since then. Malkiel is selling new editions to make money while I am selling an idea so that investors don't lose more money than they can afford.

Adrian
anenu@tampabay.rr.com

[nisiprius]

Re Malkiel and risk. All from the 2007 edition. Trying to look at what Malkiel is really saying.

P. 343 in the life-cycle chapter urges you to

Recognize Your Tolerance for Risk

By far the biggest individual adjustment to the general guidelines suggested concerns your own attitude toward risk. It is for this reason that successful financial planning is more of an art than a science.... the key to whether any recommended asset allocation works for you is whether you are able to sleep at night.... only you can evaluate your attitude toward risk....

Thus, subjective considerations also play a role in the asset allocations you can accept, and you may legitimately stray from these recommended here depending on your aversion to risk.

The "sleeping scale" chart, p. 291 is worthy of note. What is interesting is the relative conservatism of his jocular but serious descriptions.

High-quality corporate bonds, for example, do not fall into his "sound night's sleep" category. That is reserved for money market funds, "special six-month certificates," and TIPS, with bank accounts falling into two even sleepier categories. Corporate bonds, he says, "can give you an occasional dream or two, some possibly unpleasant." By the time we get to "diversified portfolio of blue-chip stock or developed foreign country common stocks" we are below the midpoint of the chart, and into "tossing and turning."

The 2007 edition recommends that someone in their "mid-twenties" hold what he characterizes as a "very aggressive" portfolio 20% bonds, 5% cash, 10% real estate (a REIT index fund being suggested in the text), and 65% stocks (1/3 international). Call that 75% stocks. That's not too far off 100 - age in stocks. Given that he appears to be talking about cash within the investment portfolio--"to take advantage of market declines and buy a few extra shares if the market is down sharply"--and that cash is more conservative than bonds, it could be considered roughly "age in bonds." It is certainly more conservative than Target Retirement 2050, which puts a 25-year-old into 90% stocks.

All that said--and not having seen the 2010 book--I do not personally like what I've heard about shifts between the 2007 and 2010 edition in the direction of higher risk, inadequately justified in the interview by claims of increased longevity.

And I do not personally like what seems to me an uncritical presentation and acceptance of what some have called the "fallacy of time diversification." The 2007 edition contains this chart:

To put it bluntly, decades ago I saw versions of this chart in two sources I trusted, TIAA educational literature and Random Walk. Lulled by the accompanying text that I trusted, I looked at the chart, "got it," and believed what I thought and think the chart and text imply: for a long-term investor, the risks of stocks become negligible.

When I encountered references in Bogleheads to John Norstad's Risk and Time paper, and read it and Bodie's comments in "Worry-Free investing," as soon as I saw the remark that one had to compound that 25-year rate out for 25 years, I instantly got that. I read the word "compound" and said to myself "of course it compounds, and if you compound that narrow little bar out for 25 years it's going to explode like a bombshell." If the compounding effect of a 1% ER is serious, the difference between 7.84% and 17.24% is going to be cataclysmic.

Yes, I felt betrayed by TIAA and by Malkiel.

The variability of stocks over holding periods of 20 years is a complicated truth. If you plan for bonds--make your plans assuming bond variation and returns--then substituting stocks is, in a sense, not risky, because the variability is all on the upside. But if you plan for stocks--making your plans assuming you will get the long-term "historical" return of the stock market--then you have incurred dangerous risk. Intentionally or not, Malkiel's presentation lulls the reader into underestimating the variability of stocks.

[re@51.5]

The variability of stocks over holding periods of 20 years is a complicated truth. If you plan for bonds--make your plans assuming bond variation and returns--then substituting stocks is, in a sense, not risky, because the variability is all on the upside. But if you plan for stocks--making your plans assuming you will get the long-term "historical" return of the stock market--then you have incurred dangerous risk.

Is this "plan for bonds" vs. "plan for stocks" the same as comparing old vs. young person, deccumulation vs. accumulation? A person will progess from "plan for stocks" to "plan for bonds".

In the 4 months since finding BHs and approaching full-retirement in about 3.5 yrs, I also believe the fixed portion of my AA is very important and where I have been spending most of time studying.

Thank you Nisi for all your thoughtful posts!

Mike

[Valuethinker]

The variability of stocks over holding periods of 20 years is a complicated truth. If you plan for bonds--make your plans assuming bond variation and returns--then substituting stocks is, in a sense, not risky, because the variability is all on the upside. But if you plan for stocks--making your plans assuming you will get the long-term "historical" return of the stock market--then you have incurred dangerous risk.

Is this "plan for bonds" vs. "plan for stocks" the same as comparing old vs. young person, deccumulation vs. accumulation? A person will progess from "plan for stocks" to "plan for bonds".

In the 4 months since finding BHs and approaching full-retirement in about 3.5 yrs, I also believe the fixed portion of my AA is very important and where I have been spending most of time studying.

Thank you Nisi for all your thoughtful posts!

Mike

Here's the non Boglehead bit (although I owe it to John Bogle for the insight).

The best guide to return for a bond or bond fund is the Yield to Maturity. Unless you buy zero coupon bonds you cannot guarantee that, but you are close.

Your other uncertainty is as to future inflation. This is where Efficient Markets come in: none of us knows whether the US is in another Japan (nominal bond yields will fall below 1.5%), whether it muddles through from here or whether inflation is much higher than the say 2% currently being discounted.

3.5% for 10 or 30 years on a US Treasury bond is going to look pretty smart if, say, US inflation averages 1% pa for the next 10 years (or 30).

You can beat that via TIPS (but there are no zero coupon TIPS: I think Barclays tried a fund, and found no interest) but then you face another (non Boglehead) problem, the fact that TIPS are only paying attractive real interest rates (or 'acceptable' real interest rates) at the long end. Again non Boglehead view: you can afford to wait for 2.5% real rates again. (rationally you should not be: since a TIPS is risk free to both credit risk and inflation risk, it should logically have a real return below nominal bonds-- ie real rates are going to stay below 1.5% as befits the true risk free instrument).

I am utterly sanguine about inflation in the next 5 years, but I don't have a forecast (other than 2% pa ) over the next 30 years, so I suggest that individuals own ST US Treasury bonds, or IT, on the basis that eventually nominal rates are likely to rise-- this recession won't last forever (in the sense of economic output below potential output ie a condition where inflation just does not accelerate).

Another alternative is investment grade corporate bonds.

You are taking a risk: take a look at 2008 for the scale of that risk. And against equities, you are lowering diversification.

However my thought is (non Boglehead):

- the corporate liquidity crisis has passed, and US corporates are piling up record profits and record amounts of cash. For this cycle, corporate credit risk is unlikely to rise

- therefore you can afford to 'chase yield' with a limited risk

If a major banking crisis erupts again, say over the problems of the Euro, then the above has just been hit by a 'black swan' and you are going to take a pounding: many IG corporate bonds are issued by financial institutions.

[Rick Ferri]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance.

I often wonder if the people who make these statements actually looked at the data. In investigating the link between fees and individual fund returns for The Power of Passive Investing, I found no evidence in the mutual fund data to suggests that low fee active funds are top performers. What the data does show is that top performing active funds have neither high fees nor low fees. Rather, their fees are about average for the category. The best you can say about low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Rick Ferri

[livesoft]

....
In my opinion, Professor Burton Malkiel's Random Walk Down Wall Street is one of the best books ever written for ordinary investors to understand how markets work.

Below are more "quotables" from his book:

A favorite "quotable" from the book is (as nisiprius also quotes previously in this thread):

"If possible, keep a small reserve (in a money fund) to take advantage of market declines and buy a few extra shares if the market is down sharply."

which continues on

"I'm not suggesting for a minute that you try to forecast the market. However, it's usually a good time to buy after the market has fallen out of bed and no one can think of any reason why it should rise. Just as hope and greed can sometimes feed on themselves to produce speculative bubbles, so do pessimism and despair react to produce market panics. The greatest market panics are just as unfounded as the most pathological speculative explosions."

PS: Thanks hsv_climber!

[bob90245]

And I do not personally like what seems to me an uncritical presentation and acceptance of what some have called the "fallacy of time diversification." The 2007 edition contains this chart:

To put it bluntly, decades ago I saw versions of this chart in two sources I trusted, TIAA educational literature and Random Walk. Lulled by the accompanying text that I trusted, I looked at the chart, "got it," and believed what I thought and think the chart and text imply: for a long-term investor, the risks of stocks become negligible.

Same can be said for bond funds and cash, not just for stock funds.

From Charles Ellis book Winning the Loser's Game:



Note, that even after holding for 25 years (!), bonds and cash can end up with a negative return after inflation.

[chaz]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance.

I often wonder if the people who make these statements actually looked at the data. In investigating the link between fees and individual fund returns for The Power of Passive Investing, I found no evidence in the mutual fund data to suggests that low fee active funds are top performers. What the data does show is that top performing active funds have neither high fees nor low fees. Rather, their fees are about average for the category. The best you can say about low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Rick Ferri

Is Vanguard Capital Opportunity fund a closet index fund?

[nisiprius]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance.

I often wonder if the people who make these statements actually looked at the data. In investigating the link between fees and individual fund returns for The Power of Passive Investing, I found no evidence in the mutual fund data to suggests that low fee active funds are top performers. What the data does show is that top performing active funds have neither high fees nor low fees. Rather, their fees are about average for the category. The best you can say about low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Rick Ferri

Oh, darn that pesky old data. Always getting in the way of a pretty concept.

[Rick Ferri]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance.

I often wonder if the people who make these statements actually looked at the data. In investigating the link between fees and individual fund returns for The Power of Passive Investing, I found no evidence in the mutual fund data to suggests that low fee active funds are top performers. What the data does show is that top performing active funds have neither high fees nor low fees. Rather, their fees are about average for the category. The best you can say about low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Rick Ferri

Is Vanguard Capital Opportunity fund a closet index fund?

I have no idea. Is it?

The data suggests that low-fee active funds tend to be closet index funds. It does not suggest that all low-fee active funds are closet index funds.

Rick Ferri

[chaz]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses. That is the thing that I find that is most reliably related in period after period to performance.

I often wonder if the people who make these statements actually looked at the data. In investigating the link between fees and individual fund returns for The Power of Passive Investing, I found no evidence in the mutual fund data to suggests that low fee active funds are top performers. What the data does show is that top performing active funds have neither high fees nor low fees. Rather, their fees are about average for the category. The best you can say about low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Rick Ferri

Is Vanguard Capital Opportunity fund a closet index fund?

I have no idea. Is it?

The data suggests that low-fee active funds tend to be closet index funds. It does not suggest that all low-fee active funds are closet index funds.

Rick Ferri

I don't know - that's why I posed the question.

[nisiprius]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses.

I found no evidence in the mutual fund data to suggests that low fee active funds are top performers.... low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Is Vanguard Capital Opportunity fund a closet index fund?

I have no idea. Is it?

Doesn't look like it to me.

[Rick Ferri]

I don't know or care for that matter. Actively managed funds only interest me when a low-cost, broadly diversified index fund or ETF isn't available that covers an asset class (such as municipal bonds and high yield corporate bonds). Vanguard may have had a few actively managed equity funds that outperformed on a risk-adjusted basis using a three-factor analysis method (adjusted for beta, size, and style risk). I'm just not interestd enough to look because I'm done playing that game.

Rick Ferri

[Taylor Larimore]

Hi Rick:

I'm just not interesting in playing that game anymore.

That's what happens when you do your research.

[chaz]

The surest way to find an actively managed fund that will have top quartile returns (or those in the top 25 percent) is to look for a fund that has bottom quartile expenses.

I found no evidence in the mutual fund data to suggests that low fee active funds are top performers.... low fee active funds is that they perform closer to the indexes than high fee active funds because they tend to be closet index funds.

Is Vanguard Capital Opportunity fund a closet index fund?

I have no idea. Is it?

Doesn't look like it to me.

nisiprius, thanks for your input.

[etarini]

I may have missed this in the posts above, but I don't think anyone's mentioned Malkiel's asset allocation changes from 2007 to 2011, which, in my opinion, add to risk.

See this portfolio, which increases international stock exposure from 16% to 28%, stocks in total from 50% to 55.5%, and reduces bonds:

2007
Cash 5%
Bonds 32.5%
Real Estate 12.5%
U.S. stocks 34%
Emer. Mkts Int'l stocks 7.5%
Developed Mkts Int'l stocks 8.5%

2011
Cash 5%
Bonds 27.5%
Real Estate 12%
U.S. stocks 27.5%
Emer. Mkts Int'l stocks 14%
Developed Mkts Int'l stocks 14%

Here's the article that was the source: http://blog.oregonlive.com/finance/2010/12/random_walk_author_malkiel_bul.html

Eric

[ourbrooks]

Etarini, have you actually done any calculations about whether the portfolio shift has increased risk? Just because he's slightly reduced his bond allocation doesn't mean he's increased risk; increasing the international allocation with its not perfect correlation with domestic stocks may have actually reduced his risk overall.

[Rick Ferri]

I think you're giving Dr. Malkeil far to much credit as an asset allocation guru. He is not. Most of the academics I've met don't spend hardly any time on asset allocation issues, especially when it comes to their own accounts.

Asset allocation strategy is something that's often discussed, and rarely implemented with any degree of discipline. People say they have an asset allocation, but few actually follow one. For example, I would be surprised if more than 10% of the directors at Vanguard could tell you within 10% accuracy what their personal asset allocation is.

Honestly, I'm not joking about this. Creating an asset allocation is easy; implementing it once is tough; following one religious is almost impossible. This is why advisors exist, BTW.

Rick Ferri

[etarini]

Etarini, have you actually done any calculations about whether the portfolio shift has increased risk?

No, I haven't, and for all I know you could be right. It also depends on exactly what kind of risk we're talking about. You can make a point about correlations or lack thereof, but are we talking about reducing standard deviation, or improving expected return, or what?

For example, I'm not sure what kind of past data exists for emerging market stocks - how do you define an emerging market country - which countries qualify, when does it move out of the emerging market category and move into the "developed" category, and what about those countries/markets that are in-between? How efficient and transparent are some of these markets and countries, anyway?

My point was that most of the time when you see a recommendation to increase stocks, especially nearly doubling emerging market stocks and international stocks generally, and to reduce bond holdings, you might reasonably expect that risk is being increased. I'd say that the person contending that risk is NOT increased is the one who needs to prove the case, no?

Eric

[tetractys]

I do not think that a 5-year improvement has been achieved since the last edition of A Random Walk Down Wall Street, four years ago.

If "age in bonds" was appropriate in 2007, and if life expectancy is the rational for changing it, then "age - 4 months" would be appropriate today... a shift of 0.3% from bonds to equities, not 5%.

Maybe Malkiel hasn't changed his bond recommendation since the first edition of 'Random walk.' And even if he has, but was on the fence between 5% more or less in any of the earlier editions since, then even a small change in life expectancy could be rationale for a bump up to the next 5%. -- Tet

[Quarantine]

Sorry for bumping a slightly old topic, but I was googling about this book's 10th edition and saw this topic here.

So yep, I'm new here.

I'm currently reading the 9th edition (2007), 180 pages in. Does anyone who have purchased the 10th edition think if it's worth getting it, for someone who has read the 9th?

Edit: Forgot to add that I'm as new to the forum as I am to doing self-directed investment. A few months ago, I have engaged in an independent financial planner whose trading platform involves a wrap account.. so yeah. Someone pointed me to A Random Walk Down Wall Street, so I've only started reading this a few days ago and found it most interesting.

Also I'm not from the States, so I'm not sure how relevant some of the advice from the book can be (or other books like Four Pillars), but I've also planned to open an account with an online brokerage platform to do my future investment in index funds.

[staythecourse]

I think you're giving Dr. Malkeil far to much credit as an asset allocation guru. He is not. Most of the academics I've met don't spend hardly any time on asset allocation issues, especially when it comes to their own accounts.

Asset allocation strategy is something that's often discussed, and rarely implemented with any degree of discipline. People say they have an asset allocation, but few actually follow one. For example, I would be surprised if more than 10% of the directors at Vanguard could tell you within 10% accuracy what their personal asset allocation is.

Honestly, I'm not joking about this. Creating an asset allocation is easy; implementing it once is tough; following one religious is almost impossible. This is why advisors exist, BTW.

Rick Ferri

Great comments Mr. Ferri. I agree completely.

Its funny that people obsess over small factors (5 or 6% of an asset), but do not focus on what trully matters including: 1. Asset allocation at the superasset class level and 2. staying the course through thick and thin.

Those two points above decides your fate and not "should I have 5% in a material ETF or 2% in a internationa small value". Which is what majority of the posts seem to ask.

Kudos on calling out what people lose focus on (which takes a lot of discipline and focus to accomplish in "staying the course").

[Quarantine]

I think you're giving Dr. Malkeil far to much credit as an asset allocation guru. He is not. Most of the academics I've met don't spend hardly any time on asset allocation issues, especially when it comes to their own accounts.

Asset allocation strategy is something that's often discussed, and rarely implemented with any degree of discipline. People say they have an asset allocation, but few actually follow one. For example, I would be surprised if more than 10% of the directors at Vanguard could tell you within 10% accuracy what their personal asset allocation is.

Honestly, I'm not joking about this. Creating an asset allocation is easy; implementing it once is tough; following one religious is almost impossible. This is why advisors exist, BTW.

Rick Ferri

Great comments Mr. Ferri. I agree completely.

Its funny that people obsess over small factors (5 or 6% of an asset), but do not focus on what trully matters including: 1. Asset allocation at the superasset class level and 2. staying the course through thick and thin.

Those two points above decides your fate and not "should I have 5% in a material ETF or 2% in a internationa small value". Which is what majority of the posts seem to ask.

Kudos on calling out what people lose focus on (which takes a lot of discipline and focus to accomplish in "staying the course").

I haven't read Four Pillars of Investing yet so sorry for this newbie-ish question. When you say "Asset allocation at the superasset class level", are you referring to broad descriptions like "stocks", "bonds" and "cash"?

[Taylor Larimore]

Hi Quarantine:

I haven't read Four Pillars of Investing yet so sorry for this newbie-ish question. When you say "Asset allocation at the superasset class level", are you referring to broad descriptions like "stocks", "bonds" and "cash"?

I am reasonably confident that is what staythecourse intended to describe.

[Malkielino]

Isn't the optimum pretty broad, and unpredictable, so, isn't high-precision asset allocation relatively low priority?

Regular disciplined rebalancing and staying the course, those are, I thought, pretty much the real keys to success... not whether you have 5% REITs and 12.5% Emerging Markets or vice versa.

Also, the whole philosophy of the `Random Walk' is that expert advisers aren't worth their cost. Hiring someone to do your rebalancing and to remind you to regularly invest and not panic may or may not be cost-effective.

BTW, interesting work by wade on lifecycle funds over at...

http://www.bogleheads.org/forum/viewtopic.php?t=67206&mrr=1296467138&start=50

[staythecourse]

I think you're giving Dr. Malkeil far to much credit as an asset allocation guru. He is not. Most of the academics I've met don't spend hardly any time on asset allocation issues, especially when it comes to their own accounts.

Asset allocation strategy is something that's often discussed, and rarely implemented with any degree of discipline. People say they have an asset allocation, but few actually follow one. For example, I would be surprised if more than 10% of the directors at Vanguard could tell you within 10% accuracy what their personal asset allocation is.

Honestly, I'm not joking about this. Creating an asset allocation is easy; implementing it once is tough; following one religious is almost impossible. This is why advisors exist, BTW.

Rick Ferri

Great comments Mr. Ferri. I agree completely.

Its funny that people obsess over small factors (5 or 6% of an asset), but do not focus on what trully matters including: 1. Asset allocation at the superasset class level and 2. staying the course through thick and thin.

Those two points above decides your fate and not "should I have 5% in a material ETF or 2% in a internationa small value". Which is what majority of the posts seem to ask.

Kudos on calling out what people lose focus on (which takes a lot of discipline and focus to accomplish in "staying the course").

I haven't read Four Pillars of Investing yet so sorry for this newbie-ish question. When you say "Asset allocation at the superasset class level", are you referring to broad descriptions like "stocks", "bonds" and "cash"?

David Darst of Art of Asset Allocation has the superasset classes nicely divided into: Equities, Bonds, Cash, and Alternative Investments.

So debating between 5% small cap vs. 10% international large cap does not make AS MUCH as a difference as between the % divided between: Stocks/ bonds/ cash/ Alternative investments. Darst and Harry Browne seem to really understand the importance of diversification at the super asset class level. One through a tactical and the other through a strategic method. This level of diversification is the best way to reduce volatility in the overall portfolio, in my opinion.

[tadamsmar]

Etarini, have you actually done any calculations about whether the portfolio shift has increased risk?

No, I haven't, and for all I know you could be right. It also depends on exactly what kind of risk we're talking about. You can make a point about correlations or lack thereof, but are we talking about reducing standard deviation, or improving expected return, or what?

For example, I'm not sure what kind of past data exists for emerging market stocks - how do you define an emerging market country - which countries qualify, when does it move out of the emerging market category and move into the "developed" category, and what about those countries/markets that are in-between? How efficient and transparent are some of these markets and countries, anyway?

My point was that most of the time when you see a recommendation to increase stocks, especially nearly doubling emerging market stocks and international stocks generally, and to reduce bond holdings, you might reasonably expect that risk is being increased. I'd say that the person contending that risk is NOT increased is the one who needs to prove the case, no?

Eric

Malkeil did not contend that the risk was not increased.

I guess Mr. Strawman needs to step up and prove the risk is not increased.

[tadamsmar]

Sorry for bumping a slightly old topic, but I was googling about this book's 10th edition and saw this topic here.

So yep, I'm new here.

I'm currently reading the 9th edition (2007), 180 pages in. Does anyone who have purchased the 10th edition think if it's worth getting it, for someone who has read the 9th?

Edit: Forgot to add that I'm as new to the forum as I am to doing self-directed investment. A few months ago, I have engaged in an independent financial planner whose trading platform involves a wrap account.. so yeah. Someone pointed me to A Random Walk Down Wall Street, so I've only started reading this a few days ago and found it most interesting.

Also I'm not from the States, so I'm not sure how relevant some of the advice from the book can be (or other books like Four Pillars), but I've also planned to open an account with an online brokerage platform to do my future investment in index funds.

There is a good bit of difference in the 10th vs the 9th on more contemporary issues and details. The basics are the same.

[tadamsmar]

When I encountered references in Bogleheads to John Norstad's Risk and Time paper, and read it and Bodie's comments in "Worry-Free investing," as soon as I saw the remark that one had to compound that 25-year rate out for 25 years, I instantly got that. I read the word "compound" and said to myself "of course it compounds, and if you compound that narrow little bar out for 25 years it's going to explode like a bombshell." If the compounding effect of a 1% ER is serious, the difference between 7.84% and 17.24% is going to be cataclysmic.

Yes, I felt betrayed by TIAA and by Malkiel.

Malkiel recommends the old 4% withdrawal rate in the 2010 edition. I think he recommended 4.5% in the 2007 edition or some earlier edition. Therefore, the attentive reader is guided to a plan that is reasonably consistent with the risks of the AA plan he recommends, and not to some reckless plan that you seem to think is implied by the annualized range of stock returns from that backtest.

[Quarantine]

David Darst of Art of Asset Allocation has the superasset classes nicely divided into: Equities, Bonds, Cash, and Alternative Investments.

So debating between 5% small cap vs. 10% international large cap does not make AS MUCH as a difference as between the % divided between: Stocks/ bonds/ cash/ Alternative investments. Darst and Harry Browne seem to really understand the importance of diversification at the super asset class level. One through a tactical and the other through a strategic method. This level of diversification is the best way to reduce volatility in the overall portfolio, in my opinion.

So to apply the philosophy of diversifying through superasset classes in real world scenarios, does not mean investing in broad market indexes like Vanguard Total Stock Market Index Fund, Vanguard Total Bond Market Index, etc? What about international indexes like Vanguard's FTSE All-World ex-US Index?

Sorry, I'm still trying to wrap my head around these concepts.

What does "alternative investments" entail?

There is a good bit of difference in the 10th vs the 9th on more contemporary issues and details. The basics are the same.

Ah that's what I had wanted to know. I'll see if I can pick it up at the local bookstore.

[at]

[Brent Hunsberger:] Do you subscribe to the idea that investors should invest their age in bonds?

[Burton Malkiel:] No, I think that's too conservative. I actually changed my bond allocations in the 10th edition. I added about 5 percent to equities and took them away from bonds because, look, people are living longer.

I am sorry to hear this facile rationalization coming from the mouth of Burton Malkiel.

Source of data: http://www.cdc.gov/nchs/data/hus/hus200 ... ble024.pdf
The CDC website doesn't seem to have anything more recent than 2007

Life expectancy at age 65 increased by a total of 2.2 years over the 27-year period shown.

That's a rate of less than one month per year.

I do not think that a 5-year improvement has been achieved since the last edition of A Random Walk Down Wall Street, four years ago.

If "age in bonds" was appropriate in 2007, and if life expectancy is the rational for changing it, then "age - 4 months" would be appropriate today... a shift of 0.3% from bonds to equities, not 5%.

The blog did quote Mr Malkiel as saying that bonds are not attractive now as an investment alternative and I tend to agree with him especially since stocks are now more reasonably priced.

OTOH, Mr Malkiel also decides to increase emerging markets which I find discerning since emerging stocks have gone through a run for quite a number of years. Is this rear mirror investing?

The portfolio he recommends is still a balance portfolio although I don't agree with the 100% equity comment he made.

We all agree to disagree.

[staythecourse]

[quote="QuarantineSo to apply the philosophy of diversifying through superasset classes in real world scenarios, does not mean investing in broad market indexes like Vanguard Total Stock Market Index Fund, Vanguard Total Bond Market Index, etc? What about international indexes like Vanguard's FTSE All-World ex-US Index?

Sorry, I'm still trying to wrap my head around these concepts.

What does "alternative investments" entail?
[/quote]

Hi,

To use your examples: I think it is more important to decide between your % of stocks vs. bonds (total stock market+ total international vs. Total bond) (superasset class diversification) as opposed to what % of equities in total stock vs. total international (subasset class diversification).

The reason for diversification is to lower risk when you need it most. When there are severe economic stresses such as 2008 all equities will get hit hard irregardless of % in domestic vs. international. Now a portfolio well diversifed in the other super asset classes, like: bonds, cash, and alternative investments will have different returns during that same economic period of stress which would have lessened the drop of your equity %.

Some alternative investments I consider worthwhile are the one's Darst and others have found useful during periods of high inflation, such as:
Real estate, farmland, commodities, gold, and hopefully TIPS.

[TigerNest]

Professor Malkiel's class in college is what made me a Boglehead. He was relentlessly pro-passive indexing and presented a very convincing case to my impressionable mind.

I'm surprised to hear that the latest re-iteration of his book may not have stood the test of time. I'll have to read the latest version.

[pkcrafter]

Quarantine and staythecourse,

Just to be clear, the term superasset class is not normally used on this forum. You can tell by Taylor Larimore's (correct) guess at what it meant. Stocks, bonds, and cash are simply called the major asset classes. What is the same though, is the importance of the allocation between stocks and non-stocks as this determines most of an investors risk.


Paul

[Quarantine]

staythecourse: Ah I think I get what you mean about the importance of stocks/bonds diversification now.

Another question: So once I've determined the allocation between stocks vs bonds, how does one decide (or what sort of judgement should one use for) what kind of index and what % to invest in?

For example, let's say I've decided on 80/20 for stocks/bonds, and I also want to invest in both the local US stock market index and international stock market index - does it make sense to just split evenly the amount I've allocated for stocks since the % of subasset class diversification isn't as important?

Paul, thanks. I'll try and remember that terminology (I have too much of CAPM, APT, etc in my head right now - currently at page 200+ with A Random Walk Down Wall Street ).

[tadamsmar]

Professor Malkiel's class in college is what made me a Boglehead. He was relentlessly pro-passive indexing and presented a very convincing case to my impressionable mind.

I'm surprised to hear that the latest re-iteration of his book may not have stood the test of time. I'll have to read the latest version.

I think it's a bit extreme to say that it has not stood the test of time.

I think the detractors are nit picking.

[staythecourse]

Quarantine and staythecourse,

Just to be clear, the term superasset class is not normally used on this forum. You can tell by Taylor Larimore's (correct) guess at what it meant. Stocks, bonds, and cash are simply called the major asset classes. What is the same though, is the importance of the allocation between stocks and non-stocks as this determines most of an investors risk.


Paul

I understand this is a boglehead forum, but using that classification forgets about Alternative Investments, the 4th asset class. These have been shown to do well in periods of high inflation. Darst's book, for instance, has a great table on how these different superasset classes do during different economic environments. The data is from 1870- 2000 (long enough I would think) and shows certain alternative investments do well during periods of high inflation (CPI>4-5).

Vanguard itself has a paper stating the mistakes people make on diversifying from "bottom up" instead of "top down". I understood this as focusing on subasset classes instead of superasset classes.

[staythecourse]

staythecourse: Ah I think I get what you mean about the importance of stocks/bonds diversification now.

Another question: So once I've determined the allocation between stocks vs bonds, how does one decide (or what sort of judgement should one use for) what kind of index and what % to invest in?

For example, let's say I've decided on 80/20 for stocks/bonds, and I also want to invest in both the local US stock market index and international stock market index - does it make sense to just split evenly the amount I've allocated for stocks since the % of subasset class diversification isn't as important?

Paul, thanks. I'll try and remember that terminology (I have too much of CAPM, APT, etc in my head right now - currently at page 200+ with A Random Walk Down Wall Street ).

The index one chooses is up to each investor of what piece of coverage they want. My opinion here, is like Taylor's, keeping it simple until you learn more. Just use TSM, Total international, Total bond as a starting point and you can alway do more as you learn more. If you can "stay on course" these 3 funds will give you 70-80% of the returns as anyone else's complicated investment plan in the next 40 yrs.

The way I look at the first step of asset allocation isdeterming the % in equities you want. This single decision will basically decide the volatility of your portfolio. I use, what I coin the "PMD" or Percent Maximum Drop, which is easy to comprehend. The PMD is just the acceptance the equity % you can cause a drop in the overall portfolio of half of that equity percent. This holds true for any period outside of the Great Depression. For example: If you go with 80/20 allocation you have to be able to withstand a drop of 40% of your portfolio value.

Once you figure that out then you can start subasset class diversificaton. How much between U.S. vs. foreign? If you use historical data by Vanguard and some others they suggest 60-80% U.S. and 20-40% foreign mix. But, if you use world weighted it is 45/55% U.S./foreign. Most would stick with 50-70% U.S. the rest foreign.

There is no way of knowing which is right until we look back retrospectively in about 40 yrs. You can't predict the future in the markets, but can control how much you save/ invest, costs, and taxes.

[Quarantine]

staythecourse: Ah I think I get what you mean about the importance of stocks/bonds diversification now.

Another question: So once I've determined the allocation between stocks vs bonds, how does one decide (or what sort of judgement should one use for) what kind of index and what % to invest in?

For example, let's say I've decided on 80/20 for stocks/bonds, and I also want to invest in both the local US stock market index and international stock market index - does it make sense to just split evenly the amount I've allocated for stocks since the % of subasset class diversification isn't as important?

Paul, thanks. I'll try and remember that terminology (I have too much of CAPM, APT, etc in my head right now - currently at page 200+ with A Random Walk Down Wall Street ).

The index one chooses is up to each investor of what piece of coverage they want. My opinion here, is like Taylor's, keeping it simple until you learn more. Just use TSM, Total international, Total bond as a starting point and you can alway do more as you learn more. If you can "stay on course" these 3 funds will give you 70-80% of the returns as anyone else's complicated investment plan in the next 40 yrs.

The way I look at the first step of asset allocation isdeterming the % in equities you want. This single decision will basically decide the volatility of your portfolio. I use, what I coin the "PMD" or Percent Maximum Drop, which is easy to comprehend. The PMD is just the acceptance the equity % you can cause a drop in the overall portfolio of half of that equity percent. This holds true for any period outside of the Great Depression. For example: If you go with 80/20 allocation you have to be able to withstand a drop of 40% of your portfolio value.

Once you figure that out then you can start subasset class diversificaton. How much between U.S. vs. foreign? If you use historical data by Vanguard and some others they suggest 60-80% U.S. and 20-40% foreign mix. But, if you use world weighted it is 45/55% U.S./foreign. Most would stick with 50-70% U.S. the rest foreign.

There is no way of knowing which is right until we look back retrospectively in about 40 yrs. You can't predict the future in the markets, but can control how much you save/ invest, costs, and taxes.

Thank you staythecourse, that's very valuable advice. I really do appreciate it.

[Taylor Larimore]

Hi Bogleheads:

My opinion here, is like Taylor's, keeping it simple until you learn more.

And when you learn more, you will still want to keep it simple as these experts advise.

Scott Adams, author of Dilbert: "I once tried to write a book about personal investing. - After extensive research I realized I could describe everything that a young first-time investor needs to know on one page."

Bill Bernstein, author of Four Pillars of Investing: "If, over the past 10 or 20 years, you had simply held a portfolio consisting of one quarter each of indexes of large U.S. stocks; small U.S. stocks; foreign stocks; and high quality U.S. bonds, you would have beaten over 90% of all professional money managers and with considerably less risk."

Richard Bernstein, Merrill Lynch strategist: "Investors find it hard to believe that ignoring the vast majority of investment noise might actually improve their performance."

Jack Bogle, Vanguard founder: "Owning a share in the entire stock market, or the entire bond market, and then holding it forever, happens to be the surest route to long-term investment success."

Jack Brennan, Vanguard CEO and author of Straight Talk on Investing: "It's in the interest of many financial service companies to make you think that investing is difficult.--It's really quite simple."

Warren Buffet, one of the world's most successful investors: "There seems to be some perverse human characteristic that likes to make easy things difficult."

Scott Burns, Columnist: "Concentrate on a simple portfolio with two basic assets--a stock index fund and a bond index fund. Do that and you'll enjoy superior performance with less risk."

Andrew Clarke, author of "Wealth of Experience": "In investing, simple is usually more productive than complex."

Jonathan Clements, author of "You've Lost It. Now What?": "Investing is simple. To be sure, you can make it ludicrously complicated."

Paul Crafter, author of "Investment Guide": "After doing it all, I now feel I've come around in a complete circle, ending up with this: The more I learn, the less I really need to know."

Charles Ellis, author of "Winning the Loser's Game": "Investment advice doesn't have to be complicated to be good."

Rick Ferri, CFA, author of "All About Index Funds": "It does not take much to outperform the average investor. All you have to do is put half your money in the Vanguard Total Stock Market and the other half in an intermediate-term bond index fund. Then rebalance your account once per year. By keeping it simple, you will achieve all the benefits the markets have to offer."

Gensler & Baer, authors of "The Great Mutual Fund Trap": "If you simply buy and hold you don't need to read investing magazines, watch financial news networks, subscribe to newsletters, or pay a broker to execute new trades."

Alan Greenspan, former chairman of the Federal Reserve: "This decade is strewn with examples of bright people who thought they built a better mousetrap that could consistently extract abnormal returns from financial markets. Some succeed for a time. But while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist."

Daniel Kahneman, Nobel Laurete: "All of us would be better investors if we just made fewer decisions"

Future Metrics looked at the performance of 224 pension plans over about 14 years compared with the performance of 60% S&P 500 index and 40% aggregate bond index benchmark. Of those 224 plans, only 19 beat that simple benchmark.

MIT study: "The less well-informed group did far better than the group that was given all the financial news."

"Michael LeBoeuf, author of "The Millionaire in You": "The master key to wealth can be summed up in just one word: Simplicity."

Burton Malkiel, author of "Random Walk Down Wall Street": "The overarching rule for achieving financial security: Keep it simple."

John Markese, CEO of American Association of Individual Investors: "If you have more than eight funds you should slap yourself."

Morningstar Guide to Mutual Funds: "Good investing doesn't have to be complicated. In fact, simplification may lead to better investment results."

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies": "You shouldn't buy anything too complex to explain to the average 12-year old."

John Rekenthaler, Morningstar Research Director: "How many funds should you have? Four to six should do."

Bills Schulthies, author of "The Coffeehouse Investor": "When you simplify your investment decisions, not only do you enrich your life by spending more time on families, friends and careers, but you enhance portfolio returns in the process."

Chandon Sengupta, author of "The Only Proven Road to Investment Success": "There is overwhelming evidence that the simplest possible investment method works much better than all the other more complex ones."

Larry Swedroe, author of "The Successful Investor Today": "Over the last 75-years, investors who simply invested passively in the total U.S. stock market would have doubled their investments approximately every seven years."

David Swensen, Yale Chief Investment Officer: "As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run."

Tweddell and Pierce, authors of "Winning with Index Mutual Funds": "Keep it simple. Investment success depends on asset allocation, diversification, and risk management, not on complexity."

Walter Updegrave, author of "The Right Way to Invest in Mutual Funds": "I advocate the KISS strategy (Keep It Simple, Stupid)."

Richard Young, author of "The Intelligence Report": "If you can't run your portfolio taking 60 minutes a month, it's too complicated."

Jason Zweig, author of "The Intelligent Investor": "The less you fool with your portfolio, the less often you'll play the fool."

[SHL]

I'm currently reading "A Random Walk" for the first time (10th Ed.), and loving every word.

It's awesome that such a timeless investment classic can be so current. The author has done a great job with all the revisions and updates.