Main lesson of the book: It is better to hold a diverse set of Index funds than it is to buy individual stocks.
I have the pleasure of reading the 12th edition of this book as it seems that the book is periodically updated to reflect the most recent developments in the market. That alone makes this this book invaluable to anyone who is interested in the Stock market. A Random Walk Down Wall Street is based on the simple hypothesis that Buying and Holding is better than Buying and Selling. To clarify that statement one needs to understand the difference between the concept of Trading and Investing. Trading is when one buys with the intent to sell within a short period of time and thus gain a “quick buck”, whereas investors are in it for the long haul and thus will only capitalize on their investments after many years or perhaps even decades. This book like some of the previous books I have read states that the only path to true wealth is a slow one. Build up your fortune, by using patience and minimizing your risk.
There are 2 main methods that investors/traders use to evaluate the market and stocks. One is the Firm Foundation Theory and the other is the Castle in the Sky theory. The firm foundation theory focuses on the company the stock is based on. The company’s possible growth, its assets and it’s value within the market. Whereas the Castle in the Sky theory is based on the promise of the markets response to the company. And past stock prices will then of course allow them to predict the future prices of the stocks. Within these 2 main methods there are an endless amount of strategies that investors/traders use to predict the market. People who use stock charts to predict future rises and falls of the market are Technical analyzers. These Technical analyzers tend to believe that the market 10% logical and 90% psychological. Which means that they fall under the Castle in the Sky theory because believing in the story of the company more so than its actual value will lead to Castles in the sky being built. There are the people who believe that the age old saying of “To know your future you must know your past.”
People who believe in the Firm Foundation Theory work with the premise that the market is 90% logical and 10% psychological. Meaning that as long as the company is capable of growth, capable of paying its bills and has a function within society that can’t be replaced it will do well. I can keep going with further strategies and drop terms such as EP, Sharpe Ratio, Beta, REIT but I would be hard pressed to then keep this chapter within 200 pages. If you want an in-depth look and understanding of all the financial terms and how they are used this is an extremely useful book. And I can surely recommend it. All the terms and strategies described in this book however are merely used to show that they aren’t foolproof or 100% guaranteed success in the market.
The book states on several occasions that the average Stock Broker or portfolio manager never exceeds the earnings made if one were to simply hold a diverse set of Index funds. This might sound weird to most but when you look at the long run, it tends to make a lot of sense. Because if one keeps running at a constant pace and the others sprints but has to stop every few minutes, the chance that they will arrive at the same place at the same time is very likely.
The thing I did learn from this book is that the market tends to get over excited for something new. Whenever society finds a new trend that it clings to, or a new development that will affect the world, the market will reflect it immediately and go Hype Crazy for a bit. And in this craze the prices will soar. There have been several of these “Bubbles” where stocks and the market go feverish for possible money earnings. If you are lucky enough to step in at the very beginning and buy the right stocks you can indeed make a lot of money if you sell at the right time, which is before the Bubble pops. But most of us who aren’t that involved in the stock market, nor do we want to invest that much time into learning its ins and outs will not be able to seize that opportunity. Because the moment a stock or investment reaches the newspapers or news its often too late as the wave has already passed.
There are of course a few lucky people who pick the right stocks and make a killing in the market. But this can be seen as nothing more than luck, because no one is able to predict the future. The book gave a beautiful example of this by stating that if 1000 people enter a coin flipping contest and the ones who flip heads will proceed to the next round, the final 20 will be seen as geniuses and heralded as coin flipping savants. But if the others that were eliminated were allowed to keep flipping they would most likely match the amount of heads being flipped because those are the rules of chance.
My favorite chapter in this book was without a doubt chapter 12 where the author explains how to actually invest and how to take your random walk down Wall Street. The first step in its rules was simple “Know yourself”. Know your “sleeping point”. Your sleeping point means exactly that, the point at which you can sleep comfortably without worrying about your portfolio. Many of us are scared of the stock market, because the chances of losing everything exists and that could possibly bankrupt you. So if you are to invest know your tolerance for risk and find the amount of money you would be OK with investing without losing sleep over it if you were to lose some or all of it. And if you are to invest, have a goal in mind as to why you’re investing. Be it retirement, studying or making sure your relatives have something if you’re to pass away, take that into account when you buy stocks or bonds. Also make sure you know the tax rules of the country or state you’re in. By understanding the rules of taxes you can avoid losing a LOT of money and if done right you might actually be able to minimize a lot of risk involved in the stock market. Another great point made in this chapter is that you need to make sure that your Buying power stays current with the current market. Inflation can destroy long term investments if they don’t take inflation into account. You should also take your time and research other venues besides individual stocks, such as Bonds and Trusts. And if you’re using a broker, keep in mind that their Commission and broker fees can really take a bite out of your possible earnings. And last but not least make sure to diversify.
The market is a living thing, and if you see a trend of stocks and prices rising, consider it the market getting excited about something new. But keep in mind that something new soon becomes old and boring and thus loses its value. Me personally I will be looking into REITS, because they align the most with what I am interested in. What will you invest in?