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Your mutual funds and the 'Random Walk'

October 07, 2013|By Michael Hiltzik
  • The New York Stock Exchange. Abandon all hope, ye who think you can beat the averages.
The New York Stock Exchange. Abandon all hope, ye who think you can beat the… (AFP/Getty Images )

Continuing a trend that dates back at least to the dawn of recorded time, actively managed mutual funds--those run by professional stock pickers--recently have been trounced by the market averages.

As my colleague Tom Petruno documented over the weekend, the trend holds month-in, month-out, over five years, over 10 years--in fact, pretty much always. Tom reminds us that the most recent results feed into a debate over "passive" versus "active" investing that has been going on for 40 years.

The debate boils down to this: Can you find a professional money manager who can consistently beat the averages? And if not, isn't it better to invest in cheap, easy index funds? 

We know the answer. It was spelled out in a classic book on investing published in 1973--yes, 40 years ago--and still very much in print. The book is "A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing." Its author, Burton Malkiel, is still with us at the age of 81. He should be dipped in gold and placed on a pedestal in front of the New York Stock Exchange, as a warning to investors that they can't profit from the brokerages' rigged game.

Malkiel had Wall Street's number from the very first. His book pointed out that the markets are "efficient"--they discount information with incredible speed, which makes it virtually impossible for any investor to consistently profit from inefficiencies. In other words, he wrote, "a blindfolded monkey throwing darts at the stock listings could select a portfolio that would do just as well as one selected by the experts."

Of course, Wall Street didn't love this truth. "Financial analysts in pin-striped suits do not like being compared to bare-assed apes," Malkiel wrote. They cooked up any number of excuses why the efficient-market theory was wrong, and any number of index-beating systems to pitch to investors. None of them works over time.

Malkiel's essential observation is that "past movements in stock prices cannot be used reliably to foretell future movements." That cuts the legs out from the "technical analysis" and charting you can see all day long on CNBC. It exposes talk of "market momentum" as sheer flapdoodle. 

Malkiel's observations don't mean that a given stock-picker or even an investment strategy won't beat the averages for some period of time, maybe even a few years. But they can't do so consistently. This year's high-flying fund managers are often next year's dogs. 

What's scary is that investors, even experienced investors, are perpetually taken in by claims to the contrary. Right now, as Petruno reported, hawkers of actively managed funds are telling investors that the stock market has risen so sharply since 2009 that the only way to win is to trust them, the pros.

But here are the raw numbers: Over the last 25 years a $10,000 investment in Vanguard's 500 fund, the grandpa of index funds, grew to $99,503. That beat the average large-cap fund by $24,000.

Do you want to do well in the stock market? Here's the best advice. Scrape together a few bucks and buy Burton Malkiel's book. Then take what's left and put it in an index fund.

Reach me at @hiltzikm on Twitter, Facebook, Google+ or by email.


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