Review: The Random Walk Guide to Investing

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Random GuideAlmost two months ago, I wrote a detailed review of Burton Malkiel’s investment classic A Random Walk Down Wall Street, which I quite liked. In terms of actual investment advice, however, it was somewhat lacking – it mostly just said that the stock market is very random and efficient, so you’re better off riding the whole market by buying broad-based index funds.

While that’s a good nutshell, it’s not really advice that’s useful for the average investor. Malkiel apparently saw the need for an expansion of the investment advice and thus wrote a companion book, The Random Walk Guide To Investing. Does this book effectively translate the ideas of the original into good investment advice, or is it merely a rehash of the original? Let’s dig in and find out.

Walking Through The Random Walk Guide To Investing

The Random Walk Guide To Investing clearly targets beginning investors; it struck me as having more directly applicable advice than Malkiel’s other book, but also written at a simpler level than A Random Walk Down Wall Street. Most of the book goes over what the cover describes as “ten rules for financial success,” most of which are simply very sound personal finance objectives. First, though, the book identifies three basic points that underline these rules.

The Basics

Basic Point 1: Fire Your Investment Advisor
Investing really isn’t complicated – it’s just often shrouded by an air of complexity that makes it seem difficult for the layman to understand. Think of those terrible “Talk to Chuck” commercials, which portray ordinary people as either uninterested in investing or else not wanting to deal with the complexity – and “Chuck” can make it easier! It’s simply not true; all your investment advisor does is take money out of your pocket either for selling stuff or doing simple things that you could have done anyway. Don’t waste your time or money.

Basic Point 2: Focus on Four Investment Categories
The four categories are cash (savings accounts), stocks, bonds, and real estate; he quickly pooh-poohs investing in precious metals, insurance, or collectibles. Cash and bonds are relatively safe places to keep money, but they don’t have high returns; stocks and real estate have high potential returns, but have risk of losses. Thus, Malkiel looks for ways to minimize risk when investing in stocks and real estate.

Basic Point 3: Understand the Risk/Return Relationship
Most investments come with a risk, but most investments that have a solid long-term basis, like the stock market as a whole, have quite a bit of risk in the short term, but in the long term the risk greatly declines. In other words, put your fingers in a lot of pies and let them sit there for a while.

The Rules

Rule 1: Start Saving Now, Not Later: Time is Money
The earlier in your life that you start saving, the longer you’ll have to have the power of compound interest work for you. Let’s say you want to break ground on an amazing house when you’re 40 and you want to have $500,000 on hand then to do it, and you can earn a 10% return each year. If you start at age 20, you only need to put away $7,813 each year. What if you start at age 25? $13,910 a year. At 30? $26,983 each year. The earlier you get started, the easier it is.

Rule 2: Keep a Steady Course: The Only Sure Road to Wealth is Regular Savings
Once you’ve started investing, don’t slack off. This takes willpower, so do things like setting up an automatic investment plan, developing a clear budget, and evaluating your life to eliminate anything you’re doing that consistently costs money. In other words, be a little frugal, because living high now can really burn you later.

Rule 3: Don’t Be Caught Empty-Handed: Insurance and Cash Reserves
The advice here is great: keep some cash reserves (i.e. an emergency fund) on hand in case of the unexpected, but have insurance in case of the disastrous. An online high-yield savings account is a great place to keep an emergency fund. As for insurance, just shop around, but stick with term life insurance because eventually you won’t need as much, insurance isn’t a great investment, and if you invest your money well elsewhere, eventually you won’t need life insurance at all. I myself have a 30 year term policy that I likely won’t renew – it’s mostly there to take care of my kids if I were to die early, but if they’re all grown, I see no reason to keep it.

Rule 4: Stiff the Tax Collector
If you have tax-deferred or tax-free accounts to put money into, take advantage of it every time. Flexible spending accounts for your medical bills, Roth IRAs, 401(k)s, and 403(b)s for your retirement, 529 college savings plans, and so on. Every time you choose to invest in one of these accounts, you not only get the investment benefits, but you don’t have to pay income tax on the money invested (in some cases ever, in other cases not until much later), meaning it’s a double win.

Rule 5: Match Your Asset Mix to Your Investment Personality: How to Allocate Your Assets
How much risk do you feel comfortable with? For many people, a high-interest savings account is the best vehicle for all of their investing because it earns a very steady return with almost no risk at all. On the other hand, stock investing does generally have better returns, but it can also have some frightening years – a 43% loss in a single year would make anyone uncomfortable, but it has happened with the broad stock market, let alone individual stocks. If the prospect of such losses literally keeps you awake at night, stick with cash and bonds. Better yet, find a mix that you’re comfortable with; if you’re half in stocks and half in cash in a 5% savings account, then even a 43% stock market drop means only a 19% loss in your total portfolio, and you don’t miss out on a big gain, either – a 15% stock market year means your whole portfolio sees a 10% gain. As you can see, the more you have in stocks, the more potential volatility you have, so find where you’re comfortable with your money and stay there.

Rule 6: Never Forget That Diversity Reduces Adversity
This means don’t invest everything in just one thing. Keep some money in cash, some in stocks, and some in bonds. Within the more risky parts, diversify even more: buy some broad-based mutual funds like the Vanguard 500, the Vanguard Small Cap Index Fund, and the Vanguard Total International Fund to keep you in big and small companies as well as domestic and international companies. This way, no matter where there’s a boom, you’ll ride some of it, but if there’s a bust your entire tent doesn’t collapse.

Rule 7: Pay Yourself, Not The Piper
This chapter really only has two points, but one above all: pay off all high interest credit card debt before you invest another dime. Paying off a high-interest debt is like making an investment that returns 19% a year, because if you don’t pay it off, you’re losing 19% a year to interest. Beyond that, when you go to invest, look at the fees you’re being charged to get that investment, and avoid anything with high fees, particularly if there is no guarantee of return (and with stocks, there aren’t).

Rule 8: Bow to the Wisdom of the Market
This is basically a brief rehash of the material in A Random Walk Down Wall Street: don’t talk yourself into thinking you can routinely beat the market because you can’t. For every winner, there’s a loser, and there are so many smart people playing the game that even the smartest lose regularly. The market is quite efficient, which means that when you hear a hot tip from your buddy, it’s either not really much of a tip or it’s blatant insider trading.

Rule 9: Back Proven Winners: Model Portfolios of Index Funds
If it isn’t clear already, Malkiel believes individual investors should be investing in index funds. This chapter gives some general portfolio samples, but they’re a bit dated as of the latest printing of the book. However, the general advice is true: have some in stocks, some in cash, and some in bonds, and the younger you are, the more you should have in stocks. However, if stock losses keep you up at night, turn those stocks into something else (cash or bonds) so that you can get some sleep – an investment should never stress you out, it should make you feel safe.

Rule 10: Don’t Be Your Own Worst Enemy: Avoid Stupid Investor Tricks
The final chapter looks at some psychological tricks that people play on themselves, such as following the herd mentality and investing in whatever the hot new thing of the moment is, or selling when the market is going down because OH MY GOD CNBC IS IN PANIC MODE. Just keep doing what you’re doing, nice and steady, and everything will be just fine.

Buy or Don’t Buy?

The Random Walk Guide to Investing fills an interesting niche as a great guide for investing for complete beginners. It’s simple and makes even my wife feel really comfortable with investment choices.

Having said that, if you want more meat, you’re better off going elsewhere. For example, if you want a more thorough investment guide that’s based on similar principles, check out The Bogleheads’ Guide to Investing (here’s my review). If you want to know more about how the stock market actually works, try A Random Walk Down Wall Street (again, my review).

This book is really great for beginners, but when you start getting into an investment mindset and having some confidence in what you’re doing, you’ll find other titles more fulfilling.

The Random Walk Guide To Investing is the twenty-ninth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.

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2 thoughts on “Review: The Random Walk Guide to Investing

  1. I’ve been investing over 10 years and I read this book last month and though it was well worth the read. I checked it out from the library. It is easy to read. Easy to understand. Comprehensive. It can be read in a few hours. Things are simplified and all the fluff is cut out. If you are looking for a simple, well explained, and historically supported investing strategy then this book delivers the goods. You can never go wrong with basics.

    I agree that if you’re looking for more detail and nitty gritty and complexity then this isn’t going to satisfy. For those that have never heard of the efficient market theory (and you should know what this theory is), you should absolutely read this book. Malkiel is one of the fathers of the efficient market theory.

    The main criticism I have with the book is Malkiel is on the board of directors at Vanguard* and this obviously gives him an angle. I felt like there were almost no counter points or pitfalls discussed with his investing philosophy.

    *To his credit he lists other recommended fund companies in addition to Vanguard with websites and phone numbers in his investment recommendations.

  2. As for firing the investment adviser, this is a popular refrain in the DIY venues such as books, magazines and web sites. A more mature outlook in my view is to be informed enough to have an intelligent discussion with an advisor.

    Consider for a moment the personal network of these advisors. The business relationship often goes beyond simply managing your money — which most people can do adequately if they acquire discipline and technique — but that scratches the surface of what is for many people a fruitful opportunity to link into a high net worth crowd. The value proposition of an advisory relationship isn’t that you will beat the market, but rather that you work with someone whose emotions aren’t getting in the way of the plan and who suggests that Joe Somebody might be a good business associate.

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