On Monday, Berkshire Hathaway
So how bad is the economy? Is it a good time to buy stocks? Can investors really beat the market? And what explains Buffett's success? Motley Fool media maven Chris Hill recently asked Princeton economics professor Burton Malkiel, author of the investing classic A Random Walk Down Wall Street.
Chris Hill: Warren Buffett said earlier this week he doesn't think we're going to have a double-dip recession. What is your take on the state of the economy right now?
Burton Malkiel: I don't think we are going to have a double-dip recession either, but I do think that we will continue to have a very plodding recovery. The problem is that consumers got themselves way over indebted. It used to be that consumers had maybe 33 cents of debt for every dollar of income. It got to the point where they had $1.33 of debt for every dollar of income. Now the consumers have started saving again. They are repairing their balance sheets, but that is not complete, and therefore I think consumption expenditures are going to continue to be restrained.
Similarly, the financial institutions in our country got themselves overextended, over indebted. They are repairing their balance sheets as well, but they are holding a lot of excess reserves. They are certainly not lending with abandon now. They need to do more repairing of their balance sheets as well. The repair of the balance sheets is not going to happen overnight. I think we are going to have a plodding recovery, but I do not see us falling into a double dip. Slow recovery, not as fast as we would like, more unemployment than we would like, but no double dip, in my view.
Time to buy?
Hill: One of my colleagues, Morgan Housel, just wrote a piece pointing out that for the first time in over a half-century, the Dow Jones dividend yield exceeds the yield on 10-year Treasury bonds (thanks to stocks like Altria
Malkiel: I do agree. When you normalize earnings in a variety of different ways, I think particularly relevant to bonds, stocks appear to me to be quite fairly valued. This is not a prediction that the stock market is going to rally over any particular period. But what I do think it means is for the long-term investor, these are quite reasonable valuations and over the long pull, people coming into the stock market now I think will do reasonably well.
Hill: A Random Walk Down Wall Street was first published in 1973; the 10th edition is coming out in November. In your book, you say investors would be better off owning passively managed index funds. Do you still believe that?
Malkiel: I believe that even more strongly than I did when I first wrote the book in 1973, when there were no index funds. What I have done with every subsequent edition is ask the question, was the advice right? Is it in fact the case that investors have done better with index funds? And every time I do it, including the data that I put together earlier this year, I find that two-thirds of active managers are beaten by a passive index and the one-third who beat the index in one year, are not the one-third who beat them in the next year.
In other words, there is very little persistence in terms of excess performance. Sure, in any period there will be people who have beaten the market, but it is not the same people from period to period. So I would say to you that I feel even more strongly today in that thesis than I did when I first wrote it almost 40 years ago.
Hill: How has your investment philosophy changed since you first wrote the book in 1973?
Malkiel: I'd say the one change; it is not really a change, but the one thing I emphasize far more than I did before is international diversification. In the '70s, the U.S. was really the sort of main stock market of the world. Today, the United States is only about 42% of the world economy. The rest of the world is growing more rapidly. By "the rest of the world," I don't mean Europe. What I mean is the emerging markets --- particularly economies like China, India, Brazil --- are growing much more rapidly than the United States.
So I think one of the things that I have emphasized more, particularly in the latest edition, is a tendency for investors to have a home country bias. That is to say, to simply invest in stocks in their own home country. I think that is a mistake. I think people are generally not sufficiently diversified internationally, and in particular, I don't think that they have the kinds of positions that they should have in the most rapidly growing emerging markets.
I'd say the other thing that probably has changed, and this is sort of one of the reasons why there are sort of new editions coming out all the time, the instruments available for investors are vastly different from what they were when I first wrote Random Walk. For example, I had mentioned earlier, index funds didn't exist when the first edition came out. Now there are lots and lots of index funds; there's a lot of competition and expense ratios have gone down.
But the other thing that you find now is you have exchange-traded funds. I am a great believer in exchange-traded funds for the long-term investor. I don't think that you ought to trade these things. I am not sure that I would use them for speculation, but expense ratios are rock bottom on the exchange-traded funds and so these kinds of new instruments are very important for people in putting their portfolios together and I don't think it is a change in philosophy, but it is a change in the kinds of instruments you can use to follow the philosophy.
Hill: What do you think is the biggest myth about the stock market?
Malkiel: I think the biggest myth about the stock market is that there are expert investors who can consistently beat the market. It just isn't true.
Now my view would be, because that isn't true, at least the core of every portfolio ought to be indexed. Now fully understand that telling an investor that you can't beat the market is like telling a 6-year-old that Santa Claus doesn't exist. And anyone with a speculative temperament is going to say, "Look, I want to go and pick some of my own stocks." And I think that is fine, and you can do it with much less risk if the core of your portfolio is indexed.
So I think things like the stuff that comes over the transom from The Motley Fool, with suggestions about individual stocks, I think this is fine for people, but I think what they ought to do is have the core of their portfolio, however, indexed. Then you can go and speculate on individual stocks with very much less risk than if it was your entire portfolio.
Hill: So if the market is efficient and investors can't consistently beat the stock market, how do you explain the success of Warren Buffett?
Malkiel: Well first of all, the kinds of exceptions, and Warren Buffett is certainly an exception, the kinds of exceptions really, it is amazing how few there are. We used to put some other people in Warren Buffett's camp and they have fallen by the wayside.
Warren Buffett is exceptional; there is no question about it. And you know what? If I had known that Warren Buffett was going to be Warren Buffett, when I first wrote the book, I would have said, "Buy Berkshire Hathaway; don't buy an index fund." And you know, there will be some Warren Buffetts in the future. There may be a few of them, but here is the problem: I don't know who they are and I don't think anyone else knows who they are; it's like looking for a needle in the haystack. And I would say fine, you want to go and try that, that is fine, but at least have the core of your portfolio in the haystack, because once you try to find that unusual person like Warren Buffett, you are more likely to do worse than average rather than getting the market return.
Let me just also say something else about Warren Buffett. I think there is a myth that Warren Buffett just reads Graham and Dodd and buys stocks that are cheap. Warren Buffett more or less buys companies. He can do things that other people can't do. In fact, take one of his first very successful investments, when he bought a big position in The Washington Post, he then was invited on to the board and was a very influential board member that helped turn the company around. He is a great businessman and a lot of the businesses he owns have been helped by his acumen, but I just think it is important to realize that it isn't simply that he is a stock picker and buys them when they are cheap and sells them when they are expensive. In fact, Warren Buffett has said the right holding period for a stock is forever.
Buy and hold
Hill: What is the strongest argument you have heard against buy-and-hold investing?
Malkiel: The strongest argument is a very obvious argument. People would say, if you just bought a U.S. index fund at the beginning of this wonderful new millennium, Jan. 1, 2000, and held it to the end of 2009, you lost money. It is what people called The Lost Decade. That is the argument against buy and hold. The problem is, if you are looking at what people actually did, early in the decade that is when they were pouring the money in and they took the money out. There were two periods in that decade where the money went out. One was the third quarter of 2002, just about at the bottom of the market. The other was the end of 2008, and again, at the bottom of the market. So when you try to do that, you try to do the timing, you invariably do the wrong thing.
And so nobody can time the market. I have never known anybody who could. I have never known anybody who knows anybody who could do it consistently. Professionals don't do it. Individuals don't do it. The best ideas are to dollar-cost average and rebalance, which is one of the most important techniques for individual investors. If you have got an allocation that is 50% bonds and 50% stocks and the stocks go way up and the bonds go down, take some money off the table and rebalance.
Hill: The 10th edition of A Random Walk Down Wall Street is coming out in November. You had mentioned that there had been some modifications that you have made to the book over time; as information changes, you have made modifications, but I am curious about one passage in particular, which is where you wrote, "A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." … I love the image of the blindfolded monkeys. Is that passage still in the book?
Malkiel: That passage is still in the book.
Hill: So do you still believe that?
Malkiel: Yes and no; I do believe and it is a nice literary image, but perhaps the more accurate analogy is rather than throwing darts, throwing a towel over the stock listings and buy and hold everything. So in fact, I do say in the new edition, "Yeah, I wrote at the beginning about the monkey and it is a great image, but the more accurate image is to throw a towel over it."
Hill: Burton, thanks so much for all your time today.
Malkiel: You are very welcome; happy to do it.
So how hard do you think it is to beat the market? Could a towel-throwing monkey improve your returns? Post your comments below.