Top 15 Burton Malkiel Quotes

Before we can determine a rational basis for making asset-allocation decisions, certain principles must be kept firmly in mind. We’ve covered some of them implicitly in earlier chapters, but treating them explicitly here should prove very helpful. The key principles are: 1. History shows that risk and return are related.
2. The risk of investing in common stocks and bonds depends on the length of time the investments are held. The longer an investor’s holding period, the lower the likely variation in the asset’s return.
3. Dollar-cost averaging can be a useful, though controversial, technique to reduce the risk of stock and bond investment.
4. Rebalancing can reduce risk and, in some circumstances, increase investment returns.
5. You must distinguish between your attitude toward and your capacity for risk. The risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income.

As a random walker on Wall Street, I am skeptical that anyone can predict the course of short-term stock-price movements, and perhaps we are better off for it. I am reminded of one of my favorite episodes from the marvelous old radio serial I Love a Mystery. This mystery was about a greedy stock-market investor who wished that just once he would be allowed to see the paper, with its stock-price changes, twenty-four hours in advance. By some occult twist his wish was granted, and early in the evening he received the late edition of the next day’s paper. He worked feverishly through the night planning early-morning purchases and late-afternoon sales that would guarantee him a killing in the market. Then, before his elation had diminished, he read through the remainder of the paper—and came upon his own obituary. His servant found him dead the next morning.
Because I, fortunately, do not have access to future newspapers, I cannot tell how stock and bond prices will behave in any particular period ahead. Nevertheless, I am convinced that the moderate long-run estimates of bond and stock returns presented here are the most reasonable ones that can be made for investment planning decades into the twenty-first century. The point is not to invest with a rearview mirror projecting double-digit returns from the past into the future. We are likely to be in a low-return environment for some time to come.

With these broad time periods set, let us now look at how the determinants of returns developed during those eras and look especially at what might have been responsible for changes in valuation relationships and in interest rates. Recall that stock returns are determined by (1) the initial dividend yield at which the stocks were purchased, (2) the growth rate of earnings, and (3) changes in valuation in terms of price-earnings (or price-dividend) ratios. And bond returns are determined by (1) the initial yield to maturity at which the bonds were purchased and (2) changes in interest rates (yields) and therefore in bond prices for bond investors who do not hold to maturity.

In principle, common stocks should be an inflation hedge, and stocks are not supposed to suffer with an increase in the inflation rate. In theory at least, if the inflation rate rises by 1 percentage point, all prices should rise by 1 percentage point, including the values of factories, equipment, and inventories. Consequently, the growth rate of earnings and dividends should rise with the rate of inflation. Thus, even though all required returns will rise with the rate of inflation, no change in dividend yields (or price-earnings ratios) will be required. This is so because expected growth rates should rise along with increases in the expected inflation rate. Whether this happens in practice we will examine below.

The amount of risk you can tolerate is partly determined by your sleeping point. The next chapter discusses the risks and rewards of stock and bond investing and will help you determine the kinds of returns you should expect from different financial instruments. But the risk you can assume is also significantly influenced by your age and by the sources and dependability of your noninvestment income.

Determining clear goals is a part of the investment process that too many people skip, with disastrous results. You must decide at the outset what degree of risk you are willing to assume and what kinds of investments are most suitable to your tax bracket. The securities markets are like a large restaurant with a variety of menu choices suitable for different tastes and needs. Just as there is no one food that is best for everyone, so there is no one investment that is best for all investors.

By telling this story, I do not mean to suggest that you attempt to cheat the government. But I do mean to suggest that you take advantage of every opportunity to make your savings tax-deductible and to let your savings and investments grow tax-free. For most people, there is no reason to pay any taxes on the earnings from the investments that you make to provide for your retirement. Almost all investors, except those who are super wealthy to begin with, can build up a substantial net worth in ways that ensure that nothing will be siphoned off by Uncle Sam. This exercise shows how you can legally stiff the tax collector.

As I’ve already pointed out, some ready assets are necessary for pending expenses, such as college tuition, possible emergencies, or even psychological support. Thus, you have a real dilemma. You know that if you keep your money in a savings bank and get, say, 2 percent interest in a year in which the inflation rate exceeds 2 percent, you will lose real purchasing power. In fact, the situation is even worse because the interest you get is subject to regular income taxes. Moreover, short-term interest rates were abnormally low during the 2010s. So what’s a small saver to do? There are several short-term investments that are likely to help provide the best rate of return, although no very good alternatives exist when interest rates are very low.

Most people need insurance. Those with family obligations are downright negligent if they don’t purchase insurance. We risk death every time we get into our automobile or cross a busy street. A hurricane or fire could destroy our home and possessions. People need to protect themselves against the unpredictable.

Remember Murphy’s Law: What can go wrong will go wrong. And don’t forget O’Toole’s commentary: Murphy was an optimist. Bad things do happen to good people. Life is a risky proposition, and unexpected financial needs occur in everyone’s lifetime. The boiler tends to blow up just at the time that your family incurs whopping medical expenses. A job layoff happens just after your son has totaled the family car. That’s why every family needs a cash reserve as well as adequate insurance to cope with the catastrophes of life.

A widely held belief is that the ticket to a comfortable retirement and a fat investment portfolio are instructions on what extraordinary individual stocks or mutual funds you should buy. Unfortunately, these tickets are not even worth the paper they are printed on. The harsh truth is that the most important driver in the growth of your assets is how much you save, and saving requires discipline. Without a regular savings program, it doesn’t matter if you make 5 percent, 10 percent, or even 15 percent on your investment funds. The single most important thing you can do to achieve financial security is to begin a regular savings program and to start it as early as possible. The only reliable route to a comfortable retirement is to build up a nest egg slowly and steadily. Yet few people follow this basic rule, and the savings of the typical American family are woefully inadequate.

Investors should certainly be aware of new methods of portfolio construction. And high net worth investors might consider adding a multifactor smart beta offering or a risk-parity portfolio to the overall mix of their investments. Factor investing can potentially increase returns at the cost of assuming a somewhat different set of risk exposures than those of a standard broad-based index fund. And investors who are able to accept the added risks inherent in leverage might profitably add a risk-parity portfolio to their set of investments. Such offerings should only be considered, however, if they are low cost and if their potentially adverse tax effects can be offset in other parts of the overall portfolio. And I continue to believe that a broad-based total stock market index fund should be the core of everyone’s portfolio. Certainly, for investors who are starting to build an equity portfolio in planning for retirement, standard capitalization-weighted index funds are the appropriate first investments they should make.

Behavioral-finance theory also helps explain why many people refuse to join a 401(k) savings plan at work, even when their company matches their contributions. If one asks an employee who has become used to a particular level of take-home pay to increase his allocation to a retirement plan by one dollar, he will view the resulting deduction (even though it is less than a dollar because contributions to retirement plans are deductible from taxable income up to certain generous amounts) as a loss of current spending availability. Individuals weigh these losses much more heavily than gains. When this loss aversion is coupled with the difficulty of exhibiting self-control, the ease of procrastinating, and the ease of making no changes (status quo bias), it becomes, as psychologists teach us, perfectly understandable why people tend to save too little.

To the great relief of assistant professors who must publish or perish, there is still much debate within the academic community on risk measurement, and much more empirical testing needs to be done. Undoubtedly, there will yet be many improvements in the techniques of risk analysis, and the quantitative analysis of risk measurement is far from dead. My own guess is that future risk measures will be even more sophisticated—not less so. Nevertheless, we must be careful not to accept beta or any other measure as an easy way to assess risk and to predict future returns with any certainty. You should know about the best of the modern techniques of the new investment technology—they can be useful aids. But there is never going to be a handsome genie who will appear and solve all our investment problems.

The paradoxical result of this analysis is that overall portfolio risk is reduced by the addition of a small amount of riskier foreign securities. Good returns from Japanese automakers balanced out poor returns from domestic ones when the Japanese share of the U.S. market increased. On the other hand, good returns from U.S. manufacturers offset poor returns from foreign manufacturers when the dollar became more competitive and Japan and Europe remained in a recession as the U.S. economy boomed. It is precisely these offsetting movements that reduced the overall volatility of the portfolio.