Malkiel Defends Efficient Market Theory

[hocus]

Here's a link to a PDF copy of an article by Burton Malkiel (author of "A Random Walk Down Wall Street") in which he says that he remains a believer in the efficient market theory. I picked the link up from a poster named "Kathyet" at the NFB site (she said that she picked it up from TMF). I don't agree with Malkiel. But I think that it is helpful for those trying to make sense of the SWR discussions to have access to such a strong statement of the argument in support of the efficient market theory from such a long-time proponent of it.

http://www.thefinancialreview.org/Financial Review Preprints/FutureIssues/Malkiel.pdf

My take is that index funds are a better choice than individual securities in many (but not all) circumstances. At today's valuations, my inclination is to limit purchases of both individual securites AND broad indexes until valuations have returned to more moderate levels. I don't say that most investors should exclude stocks from their portfolios. I think that the average investor can afford some investment in stocks even at today's price points. But I don't think that it is reasonable to expect to see the same sorts of long-term returns starting from today's valuation levels as one could expect from a starting point at which more moderate valuation levels applied.

 

[unclemick]

Malkiel sits on Vanguards board of directors - hence finding anything other than index superiority would be cause for a medical examiination.

Two things: 1)Since 10 yrs have come and gone since I bought Vg Lifestrategy - I will be taking a hard look at the Target Retirement Series after the first of the year(new tax period) and lowering the stock allocation based on my age(61). 2)Still believe in male and biological - 15% in individual stocks - div/div growth types - may add some more next year - slowly.

 

[RockMiner]

In my opinion EMH looks pretty wobbley. Value appears to have outperformed in the past, and has a good chance of continuing. The value case seems even more compelling in this (historically) high P/E environment, given the past correlation with lower returns. (Yes, I know this didn't prevent even higher prices during the bubble) The higher associated dividends don't hurt either. Are those who totally reject value in favor of indexing implicitly suggesting that "this time it's different"? I dunno.

Regression to the mean seems so powerful that it almost deserves "natural law" status. I don't have the guts to ignore it. For those who also reject any form of market timing; are you buying long maturity bonds? If not, then you are timing the market too...uh, maybe I need a glass of wine

 

[Cut-Throat]

Are those who totally reject value in favor of indexing implicitly suggesting that "this time it's different"? I dunno

Not sure what you're saying here, because indexing and value investing are necessarily mutually exclusive. There are certainly funds that are indexed to value stocks. Both large cap and Small Cap.

 

[RockMiner]

Not sure what you're saying here, because indexing and value investing are necessarily mutually exclusive. There are certainly funds that are indexed to value stocks. Both large cap and Small Cap.

Sorry, I should have said "indexing with the S&P 500" or maybe a Total Market Index to differentiate it from value indexes. Hey, it's a rant. I assume your text should have read "indexing and value investing are NOT necessarily mutually exclusive"

 

[haha]

If not, then you are timing the market too...uh, maybe I need a glass of wine  

Dude, what time zone are you in? Because we at this board do not condone all day drinking. It gives R, and especially ER, a bad name.

Now go get yourself a cup o' joe!

Mikey

 

[hocus]

we at this board do not condone all day drinking.

That explains a lot. I've been working under an understanding that it was sort of an unwritten requirement.

 

[RockMiner]

Work is the curse of the drinking class

 

[Cut-Throat]

Sorry, I should have said "indexing with the S&P 500" or maybe a Total Market Index to differentiate it from value indexes. Hey, it's a rant. I assume your text should have read "indexing and value investing are NOT necessarily mutually exclusive"

Yup, forgot the NOT - thanks

 

[Bob_Smith]

Well, after much reading, agonizing, and gnashing of teeth, I finally decided to buy into the thinking behind the small and value tilt. I have been debating since I retired rather suddenly and unexpectedly in May. I made the exchanges yesterday, and plan to hold this through thick and thin. I might increase my total allocation to stocks (now at 33%), but I plan to keep this allocation within the stock portion of my portfolio. The only thing I haven't done is buy into the REIT fund. I'm waiting for an entry point. Hopefully I won't be waiting for 20 years. I had been @ 100% TSM for the US portion. So for what it's worth, this is the stock allocation I went with:

VANGUARD TOTAL STOCK MARKET FUND 30% VANGUARD VALUE IDX FUND 15% VANGUARD TOTAL INTERNATIONAL IDX FUND 30% VANGUARD SMALL CAP VALUE FUND 15% VANGUARD REIT INDEX FUND 10%

Now that I have committed, you can all expect large cap value and small cap value stocks to take a dive, and REITs will soar for the next 30 years.

 

[unclemick]

75% Vanguard Lifestrategy moderate
10% Vanguard REIT Index

15% taxable dividend stocks.

May switch to Target Retirement in 2005 (from Lifestrategy) and add to dividend stocks.

My market timing occurs when balanced index rebalances itself.

Now in individual stocks - is it 'looking for value' or market timing? Heh,heh - I don't rebalance stocks - the attrition rate via spin offs, cash mergers, buyouts, and plain old sells due to dividend cuts over the last 15 years has been more than I liked.

 

[Cut-Throat]

Bob,

I also have a pretty strong value tilt. I did this earlier this year when REITs were considered high priced.

I'm up 19.56% in that asset class (REITs) as of today. My best performing asset class! If I would have been going by my 'smarts', I would have never put any $ in it.

Here is my Stock portion breakdown if you are interested. I'm currently 67% in stocks headed for 55% after the 1st of the year.

Vanguard Large Cap 500 Index 25% Vanguard Large Cap Value Index 25% Vanguard Smal Cap Value Index 20% Vanguard International Index 5% Vanguard European Stock Index 5% Vanguard Pacific Stock Index 5% Vanguard Energing Markets Stock Index 5% Vanguard REITs Index 10%

 

[Bob_Smith]

Cut-Throat, we have very close to the same mix! Actually, I had decided at one point to stick with the total world market with a US bias. It was a 50-50 decision. It took the end of the year approaching to get me off center. I have a daughter in college and needed to position myself before 12/31 - for financial aid purposes. Anyway, I'm glad it's done (except the REITs).

 

[73ss454]

Bob
Thanks for last months advise on Bernstein"s 4 pillars.
Also on your allocation are you also holding VanGuard bond funds?
Which bond funds would you recommend for monthly income.
Thanks,
JOE

 

[Bob_Smith]

Joe, to answer your question, I'm in the process of shuffling my bond allocation a little bit. Here's where I'll be when I'm done:

Long Term TIPS @ 2.54% Yield to Maturity 47% CDs at 4.75% to 5.25% 13% I-BONDS 28% Vanguard Short-Term Investment Grade Fund 12%

I bought the TIPS on the secondary market and they will mature in 25+ years. I plan to hold them to maturity, if I last that long.

 

[wabmester]

Well, after much reading, agonizing, and gnashing of teeth, I finally decided to buy into the thinking behind the small and value tilt.

Was there anything specific that gave you religion?

BTW, I also have some of the Vanguard Total Int'l in my port, but I'm not really impressed by the "total" aspect of it. IIRC, it's a big chunk of Europe + a smaller chunk of Japan + an even small chunk of emerging. No exposure at all to China, for example. So, I decided to overweight Asia, and most of my int'l is in ETFs.

 

[billystu]

All,

You folks look to be really diversified compared to my scary-looking 58% Berkshire, 25% cash and 17% other stocks/tips.

However, isn't there a possibitliy that all those index funds could be linked in a global currency crisis or some other global event?

If the dollar crashed what would happen to the following:

Vanguard Total Stock Market
Vanguard Value Index
Vanguard small cap
Vanguard international
Vanguard REIT

I don't know, but I'm guessing they all could fall in concert, except maybe for the REIT. I'm just wondering if everyone is as diversified as they are supposed to be or think they are, and not trying to be obstreperous.

I'm obviously, on the surface at least, not diversified but I'd rather go with what I know than to just "diversify" because I'm supposed to.

On another note, did anyone catch this Bill Gross discussion on the good outlook for short term TIPS?

http://pimcofunds.com/commentary/mgr_billGross11012004.jsp

I own some TIPS in a Vanguard fund in a tax-deferred account, but I've never bought them direct from the Treasury. Anyone do that?

billystu

 

[Cut-Throat]

However, isn't there a possibitliy that all those index funds could be linked in a global currency crisis or some other global event?

Sure, we'd all probably be screwed. - I really can't think of any investment that would be very safe.

 

[Jarhead*]

Bob,

I also have a pretty strong value tilt. I did this earlier this year when REITs were considered high priced.

I'm up 19.56% in that asset class (REITs) as of today. My best performing asset class! If I would have been going by my 'smarts', I would have never put any $ in it. :

Hey Cutthroat:

You bought Reits from me I sold half of my Reit holdings the first of the year. YTD, they are up over 30%.
I sold off another half a week ago.
After 5 years of run-up, (ala individual properties), felt like my stake in real estate was not feeling comfortable.
However, with a much longer term outlook than I have, probably a good idea to establish some kind of position in that asset class.
I plan to purchase more if they come down to earth.

 

[WilliamG]

Cut-Throat,
Curious question. You said you were currently at 67% stock and planned to go down to 55% early next year. I recall from earlier posts that your target equity allocation was 60%. Is this shift to 55% a "permanent" change in your equity target?
thanks! bill

 

[Cut-Throat]

Cut-Throat,
Curious question.  You said you were currently at 67% stock and planned to go down to 55% early next year. I recall from earlier posts that your target equity allocation was 60%.  Is this shift to 55% a "permanent" change in your equity target?
thanks! bill  

No, I will decrease my exposure to stocks the older that I get, all the way down to 25%.

Basically I am following a 110-age Formula.

I cannot shift my Allocation this year due to Tax Implications. But I want to be at 55% stocks next year.

I'll be 54 next year. Close enough.

 

[WilliamG]

Cut-Throat, thanks for sharing what you're doing. I have been at 55% equity since I retired at 55 and will soon be turning 60. I have been toying with changing to a 50-50 allocation and just leaving it there, or maybe further reducing it later as I age. I guess 50% equity would fit the 110-age approach for me right now. I really am leary of taking any more risk than I have to. Guess I'll be figuring on it some more the next few weeks! Adjusting after what may be a couple of pretty decent equity return years would also be nice ... bill

 

[Bob_Smith]

Was there anything specific that gave you religion?

Not really - it was 50/50. I do like the higher dividend yield I may get on the value side. I think I would be able to almost make it on interest and dividends without selling off as I go. But it really came down to just needing to decide and get it done. It was almost a coin toss. Actually, I doubt it will make much difference.

 

[wabmester]

Actually, I doubt it will make much difference.

Same here. I love reading the theories, but mostly just to marvel at the simplistic assumptions being made. In the end, there is no substitute for thinking.

 

[Richard Poole]

I own some TIPS in a Vanguard fund in a tax-deferred account, but I've never bought them direct from the Treasury.  Anyone do that?

billystu

Hi-

I am constructing a ladder of 10 year TIPS which I buy at treasury auction through Fidelity. Costs $50 per transaction regardless of amount. I buy $10K at a crack, with the intention of holding till maturity. .5% averaged over 10 years looks pretty good. I have also purchased some corporate inflation protected Internotes, which are similar but pay out the inflation premium monthly rather than adding it to principal. Issuers include Prudential and Household finance, and maturities range from 5 to 10 years. I think the inflation protected internotes would be a good deal for RE types who are past the accumulation phase. No fee on those - at least none that I see - I assume Fidelity gets paid by the issuer.

R