The Homa Files

Prof. Burton Malkiel has always been one of my heroes. 

He was the prof in my very first lecture in college.  I’d never heard of him since I’d just fallen off the pumpkin truck, but even I knew the guy was something special.

Four years later he was a “reader” on my college thesis.  He gave me an “A”, then wrote an article debunking my thesis.  That’s OK. If I’m going to get trashed, I want somebody of his stature doing the trashing.

Many people have heard of Prof. Malkiel because of his book “A Random Walk Down Wall Street”.  His central idea: if you try to time the market and beat the pros, you’re nuttier than a fruitcake.

Some consider Prof. Malkiel’s corrollary principles like ‘buy & hold’ and ‘portfolio balancing’ to be passe.

In a WSJ op-ed, he argues that they’re still alive and well, and can make you prosperous.

Here are some highlights …

In the wake of the recent financial crisis, many investors believe that the traditional methods of portfolio management don’t work anymore.

They think that “buying and holding” is outdated, and that success depends on skillful timing.

Diversification no longer works, they argue, because all asset classes move up and down together, especially when stock markets fall. In other words, diversification fails us just when we need it most.

And they suggest that low-cost, passively managed portfolios are no longer useful, that today’s difficult investment environment requires active management.

I don’t agree with any of these arguments. The timeless investment maxims of the past remain valid. Indeed, their benefits may be even greater today than ever before.

While no one can time the market, timeless techniques can help:

• “Dollar-cost averaging,” putting the same amount of money into the market at regular intervals, implies investing some money when stocks are high, but also ensures some buying at market bottoms. More shares are bought when prices are low, thus lowering average costs.
• The other useful technique is “rebalancing,” keeping the portfolio asset allocation consistent with the investor’s risk tolerance. Rebalancing involves selling some of the asset class whose share is above the desired allocation and putting the money into the other asset class. .
• Diversification has not lost its effectiveness. Over the past several years, when stocks went down, bonds went up, preserving the value of the portfolio. And while stock markets around the world have tended to rise and fall together, there were huge differences in regional returns.
• Also, low-cost passive (index-fund) investing remains an excellent strategy . The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period.

If you ignore the pundits who say that old maxims don’t work and you follow the time-tested techniques espoused here, you are likely to do just fine, even during the toughest of times.

WSJ, ‘Buy and Hold’ Is Still a Winner, Nov 18, 2010
http://online.wsj.com/article/SB10001424052748703848204575608623469465624.html?mod=WSJ_newsreel_opinion

This entry was posted on November 23, 2010 at 6:59 am and is filed under Investing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.