A Random Walk Down Wall Street

Malkiel summarizes the second part of the book by saying, “Fundamental analysis is no better than technical analysis in enabling investors to capture above average returns” (182). In his comparison of technical and fundamental analysis, Malkiel found that neither form of analysis can accurately and consistently predict the value of a given stock, let alone the full spectrum of stocks available on the market. As such, the professional security analysts, technicians, and portfolio managers that stake their professions on accurate and consistent predictions of the market’s performance are largely “highly intelligent” people with “an extraordinarily difficult job,” which they perform “in a rather mediocre fashion” (171). The result of these assertions reflects the theme of Comparing Long-Term and Short-Term Goals, as Malkiel admits that some individual investors and mutual funds do beat the market for short periods of time, with some sustaining an advantage over decades. However, in his analogy of a coin-flipping contest, in which the winner flips heads consistently, Malkiel notes how many contestants, including those who may flip a single tails before flipping heads consecutively, would be hailed as particularly talented or skilled, when their success is the result of plain luck. The same is true, according to Malkiel, of technicians, security analysts, and portfolio managers who achieve a measure of success compared to the market, as people are inclined to view these few individuals as specifically intelligent or talented, when they are likely just specifically lucky. With technical analysis, Malkiel notes: “If you examine past stock prices in any given period, you can almost always find some kind of system that would have worked” (159), and this same mentality can be applied to fundamentalists. By looking back over data, some viewers will conclude that a given fund or investor knew the best course of action, but these gains are not reflected across all time periods, leading to short-term results without sustainability.

The basic theme of Balancing Risk with Reward in Malkiel’s discussion of different analysis techniques underscores the luck involved: Both technicians and security analysts promise rewards, but these potential earnings come at greater risk. The technician’s methods do not hold up under any scrutiny. Malkiel notes, almost jokingly, how theories like the Hemline Theory or January Effect are entirely unreliable, but the fundamentalist, deceptively, seems to have data and science to reliably limit risk. The issue is that “there is no consistency to performance” (177), as fundamentalists fall prey to laziness, human error, conflicts of interest, and inaccurate data. The lack of consistency is what creates significant risk when various investing methods are compared against Malkiel’s main suggestion, investing in index funds. Because the index fund covers the entire market, it will perform alongside the market consistently. While a specific mutual fund or investor might outperform an index fund in one year, they are unlikely to outperform the market again the next year. Even in acknowledging that some mutual funds have beaten the market for decades consecutively, Malkiel notes that these mutual funds, too, are reliant on “our old friend Lady Luck” (177). Index funds, implicitly, do not rely on luck, but rather on the consistent performance of the market, using a buy-and-hold strategy that removes the immediate risk of moving money from one investment to another, which often carries additional taxes and fees, as well.

While Malkiel explicitly discusses The Psychology of Crowds and Markets when he notes that investors should look for stocks with “stories of anticipated growth” (139) to promote castle-building, the more prominent psychology of this section lies in the way average people perceive investment professionals. First, Malkiel comments on how “people find it hard to accept the notion of randomness” (151), which implies an order and structure to the stock market in the minds of most people. They expect that, given a greater knowledge of the system, a person should be able to predict stock values accurately and consistently. Second, Malkiel notes that “we should not take for granted the reliability and accuracy of any judge, no matter how expert” (166), which directly contradicts the psychological phenomenon noted in the first assertion. Basically, while people are inclined to believe in the reliability of a well-informed professional, Malkiel refutes that belief, noting how even the smartest professionals can be led astray by conflicts of interest, random events, or even fraudulent accounting. Additionally, as in Part 1, investment professionals often stake their reputation on successes, presenting themselves as wealthy, intelligent insiders in a world that the average person cannot comprehend, which leads regular investors to trust their money with people that are ultimately no better at predicting market trends than themselves.