The key ideas

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

Burton G. Malkiel, 1973

An economics professor showed a chart expert a chart drawn by tossing a coin, and the expert urged him to buy right away. Malkiel walks you from Dutch tulips to the internet bubble and asks whether anyone can predict prices reliably. The answer is awkward for Wall Street, but it gives ordinary people a simple, calm way to invest.

Who it is for

For anyone who saves money and doesn't know whom to trust: market gurus, analysts, or the neighbor who got rich on a hot stock. And for anyone curious why crowds blow up bubbles again and again.

Taken to its logical extreme, it means that 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.

What this book is about

Once, an economics professor asked his students to imagine a stock priced at fifty dollars and to toss a coin every day. Heads, the closing price went up half a dollar. Tails, it went down by the same amount. The professor showed one of the resulting charts to a chart expert he knew. How that meeting ended, you'll find out in the fourth idea.

The professor is Burton Malkiel of Princeton, and the book came out in 1973 and has been reissued for half a century. Its central question: can anyone keep guessing which stocks will rise? Malkiel's answer is awkward for Wall Street. Over short periods, prices move in such a way that the next step can't be predicted from the steps before it. That kind of movement is called a "random walk", which is where the book gets its title.

Ahead of you: a tulip bulb eaten instead of an onion, a test of the best analysts' forecasts, and a simple way to invest that the author proposed before anyone was selling it.

Idea 1. A price rests either on income or on the next buyer

What is a share of a company really worth? Malkiel describes two answers.

The first is the firm-foundation theory. A stock is a share of a company, and it has an intrinsic value: the money the company will bring its owner in the future. Above all, that means dividends, the part of the profit the company pays out to its shareholders. If the price is below that value, buy. If it's above, sell.

The second is the castle-in-the-air theory, which Malkiel links to the economist Keynes. A thing is worth what the next buyer will pay for it. Keynes compared the market to a newspaper contest where the winner isn't the one who picks the prettiest face, but the one who guesses what everyone else will pick. Malkiel puts it less politely: the greater-fool theory. You can pay three times the real price, as long as someone later pays five times.

How to use it: before you buy anything for income, ask yourself which of the two theories its price rests on. If the honest answer is "someone will buy it from me for more later", you're building a castle in the air.

A colleague buys rare sneakers for three times what they cost in the store. He has no plan to wear them and is sure collectors will pay even more in a year. But the sneakers are worth exactly as much as other people believe they are.

A price on a firm foundation rests on the money a thing earns. A castle-in-the-air price rests on other people's mood, and moods change faster than profits.

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About the author

Burton G. Malkiel is an American economist and a professor at Princeton University. Before academia he worked at an investment firm, and later he served on the President's Council of Economic Advisers.

All books by this author: Burton G. Malkiel

Terms from the book

  • Kahneman
  • Newton
  • bubble
  • Bonds
  • Stock
  • dividends
  • South Sea Company
  • Fundamental analysis
  • Technical analysis
  • Tversky
  • Mutual fund
  • Index fund
  • Random walk: A movement in which the next step can't be predicted from the steps before it. The book uses it to describe short-term changes in stock prices.
  • Firm-foundation theory: The book's name for the view that a stock has an intrinsic value, set by the company's future earnings.
  • Intrinsic value: An estimate of what a stock is worth, based on the money the company will bring its owner in the future, converted into today's money.
  • Castle-in-the-air theory: The book's name for the view that a thing's price is set by what other buyers will pay for it, not by the income it earns.
  • Keynes: John Maynard Keynes, a British economist of the first half of the twentieth century. He compared the stock market to a newspaper beauty contest.
  • Greater-fool theory: A mocking name for betting that something bought at an inflated price can be sold for even more to someone else.
  • Tulipmania: The speculative frenzy over tulip bulbs in Holland in the 1630s, which ended in a price collapse in 1637.
  • Efficient market hypothesis: The idea that market prices quickly reflect the information available, so beating the market consistently is very hard.
  • Index: A measure that tracks the prices of many stocks at once, for example the hundreds of largest companies in a country.
  • Behavioral finance: A field of economics that studies how people's psychological mistakes affect their money decisions and the markets.
  • Disposition effect: Investors' tendency to sell stocks that have gone up and hold on to those that have gone down, to avoid admitting a loss.
  • Dollar-cost averaging: Investing the same amount at regular intervals, whether the market is rising or falling.
  • Rebalancing: Bringing the shares of different investments, such as stocks and bonds, back to a mix you chose in advance.

All terms

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