>>Male Commentator:
Thanks everybody for coming to part of the
series on being fiscally fit. We're deeply
honored and appreciative today to have Dr.
Burton Malkiel join us from Princeton.
Dr. Malkiel is a seminal figure in finance
and economics and particularly in personal
finance.
Dr. Malkiel not only has a distinguished career
which I'll tell you briefly about, but in
many ways was-was the first person to have
the insight about what is the optimal investment
strategy, and one that's actually been proven
overtime to-to be effective.
And while there's a lot of debate about it,
it is one where if you examine the data you'll
find it actually works over just about any
measurement period, over any economic period
in the United States, which is a remarkable
achievement.
He received his Bachelor's Degree and his
MBA from Harvard University and originally
went into the business world, but always had
an interest in academic economics and eventually
earned a Doctorate from Princeton University.
He's the Chemical Bank's Chairman's Professor
of Economics at Princeton and is a two-time
Chairman of the Economics Department there.
He served as a member of the Council of Economic
Advisors from 1975 to 1977; President of the
American Finance Association; and Dean of
the Yale School of Management.
He also spent 28 years as a Director of the
Vandard-guard Group and is still very actively
involved in it and a member I believe of the
Board of their international operations.
One of the things I think you'll learn is
that people vary wildly in their ability to
assess risk, particularly when it comes to
their personal finances, and Dr. Malkiel will
give you a tremendous amount of insight into
what works and what doesn't.
Beyond that the advice I think he'll share
today with you actually has proven to be true,
it actually works, which is a useful thing
when it comes to advice.
Many of you had a copy, found a copy of his
Elements of Investing which is his latest
book; a follow-up to his decades old best-seller
A Random Walk Down Wall Street. I think you'll
enjoy his talk a great deal and I welcome
Dr. Malkiel to Google.
[applause]
>>Dr. Malkiel:
Thanks very much for your kind introduction
and thank you all for coming. I'm just delighted
to see all of you guys for as-as far as the
eye can see.
What I'm gonna do is talk to you today, I-I
call this talk "Timeless Lessons for Investors"
'cause I wanna talk about what I think are
the timeless lessons and some of them which
are in fact in question right now.
[sound of phone ringing in background]
So let me begin by talking about some things
that people now say we have presumably learned
given the past financial crisis.
One of the things that they presumably have
learned is that now you have to time the market.
After all we realize that we've just been
through a period where the market tanked,
went down almost 50%, and this shows you that
buy and hold is dead, that that's the wrong
thing to do.
And basically I don't think that that's correct.
I still believe in buy and hold for the following
reason; obviously if we knew that 2007 was
the top of the market. If we knew that, yes
we should have sold then and then bought back
in March of, of 2008, 2009 which turned out
to be the bottom of the market.
But nobody can do that. You know I've been
in the investment business for a long number
of years. I have never known anyone who could
consistently time the market, individual or
professional. And I've never known anyone
who knows anybody who could consistently time
the market. And the problem is if you try
to do it you are much more likely to be wrong
than to be right.
Now, this gives you an example of what people
actually do. And what we've superimposed here
is the solid line shows you the performance
of the world stock markets and the bar graph
shows the flow of funds into equity mutual
funds superimposed on how the market is doing.
And what you notice is that when the market
is high that's when people put their money
into the market and when the market is low
that's where people take their money out.
More money went into the market during the
Internet boom in late 1999 and early 2000
than ever before. And then in October of 2002
which was the bottom of the market, more money
went out than ever before. Similarly in the
late part of the first decade of the 2000's
when the market was high, the money poured
in.
And when did the money come out? The money
came out in early, late 2008 and early 2009that
turned out to be the bottom of the market.
So, what happens when you try to do that and
you let your emotions tell you? Because after
all what's happening is at the top of the
market all the stories are its optimistic,
everything's gonna be perfect; at the bottom
of the market the sky is falling, the world's
gonna end. That's when people take their money
out.
And so I'd much rather be a buy and hold investor
and just, 'cause I know I can't do it and
I don't think anybody can do it.
And the fact is, remember when you try to
time the market you've got to be right now
once but twice. You gotta be right when you
get out; you gotta be right when you get back
in.
And because when there are reversals in the
market they happen to quickly, it you take
a period and this was done from '94 to 2008
where the buy and hold investor had some,
and this was not a great time to be in the
market; it had a 7% return. If you had in
fact just missed the best 10 days your return
got down to practically nothing. And if you
had missed the best 30 days and remember those
best days typically were the-the-the leaps
up right at the bottom of the market when
everyone is pessimistic, you miss those days
and you actually had a negative return. So,
I say, don't try to time the market. You can't
do it. It's very dangerous.
Now not only do people make mistakes when
they try to time the market because they get
in at the top and out at the bottom, but they
buy the wrong kinds of funds.
Remember I told you more money went into the
stock market in late 1999 and early 2000 than
ever before? Well what did it go into? It
went into high-tech funds. It didn't go into
the value funds which were actually very cheap
then, and value stocks actually did well at
the beginning of the 2000's, but it went into
all of the Internet stocks.
You know, I remember so vividly as a Director
of the Vanguard Group. Our flagship Vanguard
has generally had a lot of value funds. Our
flagship value funds were losing assets and
all the assets were being taken out and you
sort of wonder where they were going, because
when you're in a mutual fund complex and there's
a redemption of a fund it goes into the money
fund.
So, you have to look at where the checks were
written from the money fund. They were all
written to this company in Denver called Janus
and they went to something called the Janus
Twenty Fund which was twenty of their best
stocks, they were all Internet stocks.
So-so this also this selection penalty that
money went into Internet stocks and out of
value stocks at the top and again I, without
going through all of the buys and things in
there, there's also a selection penalty.
There's a study that was done by a company
called DALBAR. And what it did was it tried
to compare the returns that are published
by the mutual funds or when you say the stock
market did a certain rate of return from how
individuals fared. In other words, if let's
say there's a period and this is a period
from 1988 that this was the DALBAR Study to
2007. So, it did go to the top of the market.
It's not, this is not indicative of what the
stock market is gonna do in every period.
You had an 11.6% rate of return.
But if you look at how the average investor
did realizing that the average investor wasn't
necessarily in the market at the time; that
the average investor didn't buy and hold,
wasn't buying at the beginning and holding
all the way through, the average investor
got only 4½%.
And again, that's the danger of trying to
do the timing. You can't do it. It's very
dangerous. Obviously, with perfect hindsight,
yes you should have timed the market. You
can't do it. Don't do it. You're more likely
to do it wrong than right.
And incidentally, this is true not only of
individuals but for institutional investors.
I have looked at the cash positions of active
managers, whether they're pension funds or
mutual funds, institutional investors have
more cash at the bottom and the least amount
of cash at the top. Nobody can do it; neither
amateur nor professional.
The second timeless lesson is what I will
call the Dollar Cost Averaging lesson.
Again the argument is, and most of you who
are accumulating, who are saving over time,
are taking advantage of this. There is an
advantage for putting money into the market
regularly over time.
So, what this shows you is that even though
the market was rising in what's to the right
of the screen, you actually made more money
in this volatile flat market than you did
in the rising market.
Now, it's not always true. The dollar, obviously
if the market is continuously rising you wanna
put all your money in at the beginning.
But if, in fact, we're in a situation of pretty
volatile times, you're more likely to be on
the left hand side of the screen and at the
very least you're gonna reduce your risk this
way and the regret that comes if you happen
to put all your money at the, at a market
top.
I'm very fond of the advice of Warren Buffett
who likes to give this quiz. So, you plan
to eat hamburgers all of your life. What would
you prefer? Do want lower prices of hamburgers
in the future or higher prices? And you know
obviously if you're gonna buy hamburgers you'd
like lower prices in the future. Or you wanna
buy automobiles throughout your life and you're
not an automobile manufacturer, you'd prefer
the automobiles to be lower in the future.
And now for the final exam Warren Buffett
says that most people get wrong. So you're
gonna be an-an investor all of your life,
do you want higher prices or lowers prices?
And the answer is no, you actually would want
lower prices. It's as if you're buying cheaper
hamburgers or cheaper automobiles.
It's only when you're close to retirement
that you wanna get into the safer stuff where
you take things out. And incidentally what
you have actually as part of your options,
for those of you who are getting closer to
retirement, that's why you have target-maturity
funds that in fact make sure that you're not
at a time at the end where everything's in
the stock market when the stock market might
be, might be low and the target funds do exactly
that for you.
Now, the other thing that is I think a timeless
lesson is to rebalance, and I say yearly.
My own work suggests that one oughta rebalance
yearly and this gives you an example from
January 1996 through December of last year.
That the bottom row says if you were not rebalanced
you simply start off with a balanced portfolio
of 60% stocks and we'll say you're in an index
fund what is called generally a total stock
market index fund, which in the Vanguard case
is with the Russell 3000. and 40% the Broad
Bond Market Index which this says the Lehman,
unfortunately it's now called the Barclay's
Club of --
I know something must have happened to Lehman
along the way --
[laughter]
I'm not sure what it -- what it was.
So, if you were not rebalanced you had an
8¾% return.
And then if you just simply said I wanna be
60/40 and I'm gonna rebalance every year,
that's what the top row suggests. So, every
year you look at the portfolio if you're away
from 60/40 you go back to 60/40. And you have
a rate of return that's well over 1% point
higher.
So, why does it work? Well, it works for the
following reason. Just think. You can't time
the market but let's say we're gonna rebalance
in January of every year.
So, you started off 60/40, we're now in, say,
January of 2000. You don't know it's the top
of the market. Nobody knows it's the top of
the market. But what you do know is that your
stocks are sky high and the Federal Reserve
was increasing interest rates which means
bond prices fell and your bonds were low.
So, you might have had 75%t in stocks and
25% in bonds, and so you say you take some
money off the table, you take it from the
stocks and put it into the bonds.
You're then January of 2003. You don't know
you're just after the lull of the market,
but what you found was the Federal Reserve
had lowered interest rates so bond prices
were up. So, your bonds might have been 50,
55%; stocks were in the tank. So, stocks were
well below your target and so you then sold
some bonds and bought some stocks.
That's why this works and rebalancing, again
if the stock market does nothing but go up,
go straight up even then what it-it'll work
in that it gives you much less volatility,
but you won't quite get the extra return.
But again, if we're gonna be in volatile markets,
rebalancing is-is gonna not only reduce your
volatility but it's going to increase your
rate of return.
Now, the other timeless lesson that I hear
all the time saying, "Boy diversification
doesn't work anymore." We learned that in
2008 and early 2009 there were few places
to hide: everything went down together; emerging
markets went down; the U.S. market went down.
Diversification doesn't work anymore. That's
I-I can't tell ya how often I read that.
Well, first of all if you were in bonds, if
you had some bonds in your portfolio, diversification
did work.
What we know about diversification, you get
the most benefit when you buy an asset class
that tends to be uncorrelated or very lowly
correlated with, say your main asset is U.S.
Stocks. Bonds actually have become a better
diversifier over time in that the correlations
have actually fallen. So, there were places
to hide.
In fact, in fact what happened with bonds
was the Federal Reserve was reducing interest
rates to essentially zero and bond prices
were going up. So, bonds were a place to hide.
Now. it's true that all world stock markets
became very highly correlated, and globalization
has tended to increase the correlations among
markets. But even though the correlations
have gone up, it still paid to be diversified
internationally because here you have a graph
of the emerging markets in the decade from
2000 to 2010.
And it's something that people often call
the lost decade because it was not a good
time. These are worldwide stocks. It was not
a good time to be in the stock market. You
ended up about the same place that you began,
but emerging markets gave you a 10% annual
rate of return.
So, even though the ups and downs are the
same, it-it's the fact that they look like
they're very highly correlated and they are
highly correlated, that still didn't mean
that you didn't wanna be diversified because
you did much better if you were diversified
and had some of the emerging markets.
And again, let's sort of put these things
together, the advantages of diversification,
rebalancing, and Dollar Cost Averaging.
You have at the bottom of the slide the lost
decade, you were in the S&P 500, you didn't
make a penny, you in fact lost some money.
And in the tops part of the graph it says
you're diversified, you have bonds, you have
some international stocks including emerging
market stocks, and you do a little bit of
Dollar Cost Averaging. And in the first case
your hundred thousand dollars declines to
eighty thousand dollars and in the second
case your hundred thousand dollars goes up
to two hundred and fifty thousand dollars.
So, it basically just gives you some numbers
to go away with what I've called the timeless
lessons, that by diversifying, Dollar Cost
Averaging, and rebalancing you get a much
better investment performance.
The next slide - and I'll try to tell you
who, those of you who don't see the slides
what this shows you is that costs matter.
You know, I think all of us need to be very
modest about what we know about financial
markets and what we don't know, but I will
tell ya the one thing that I am absolutely
certain of. And the one thing I'm absolutely
certain of is the lower the costs charged
by the purveyor of the investment service,
the more there will be for you.
[laughter]
You know it sounds so obvious, but it is just
absolutely the case. As the founder of the
Vanguard Group, Jack Bogle, likes to say,
"In the investment business, you get what
you don't pay for."
[laughter]
And what this does is it breaks down all mutual
funds and these are not just, these are actively
managed funds, this is every mutual fund there
is in the United States, and it divides them
into quartiles. The low-cost quartile has
lowest turnover and the lowest explicit expense
ratio. The high-cost quartile has the highest
costs and the highest portfolio turnover.
And the low-cost quartile gives you an 8.66%rate
of return. The high co-cost quartile gave
you a 6.66 and this is the period 1994 through
the end of last year - the end of '09. So
you've got two percentage points more a year.
And I've done all kinds of studies for how
do ya pick the mutual funds that do best.
The only thing that is reliably related to
how mutual funds do is the costs they charge.
And so, the one thing you can control of the
costs you pay, you want to have funds that
charge the lowest in expenses.
And that brings me to one of my favorite subjects
is that you ought to also use, at least to
some extent, index funds because the quintessential
lo- cost funds are index funds that simply
buy and hold a broad portfolio and charge
minimal, I mean it, they're very close to
zero expense ratios.
Now, I've always argued that index funds make
sense first of all because markets are reasonably
efficient. You know, there are a lot of very
smart people out there looking for every opportunity
to buy cheap stocks and they therefore give
you a tableau of market prices that makes
it very difficult to find really cheap stuff.
You know, the way we academics like to tell
this is the sort of story about the efficient
market professor who is walking along with
a couple of graduate students and the graduate
students see a hundred dollar bill on the
ground and one of the graduate students stoops
to pick it up and the professors says, "Don't
bother to pick it up. If it were really a
hundred dollar bill it wouldn't be there."
[laughter]
You know I'm not quite that extreme. I tell,
I tell the graduate student, "Pick it up right
away because it isn't gonna be there for long."
[laughter]
I mean we-we just don't leave hundred dollar
bills on the ground very long.
So, that's one reason why you oughta be in
index funds, but even if you don't agree with
me that markets are pretty efficient, indexing
still have to be an optimal strategy because
when you think about it investing has to be
a zero-sum game.
That is to say we're all different investors,
we buy different stocks, it's since all the
stocks have to be held by somebody, it must
be that if I just buy the stocks that go up
the most, somebody else has had to have the
stocks that didn't go up. Th-this is just
we-we don't live in Lake Wobegon. We cannot
all be above; we can't all be above average.
So, if you think of it then, that if half
the people are better than the market, half
of them have to be below the market, you realize
it's a zero-sum game. But in the presence
of costs, if you now say that on average,
and this is the, this is true, that on average
purveyors of investment products charge one
percentage point in costs, that means that
if the market does 8% you've shifted the whole
distribution over in that everybody's gonna
get whatever they got from their portfolio
minus the 1% of cost. It then must be that
most people will underperform the market.
If you could buy an index fund that has the
whole market at essentially zero cost and
that's really the, you know, it's a matter
of arithmetic that since index funds are available
at, you know, something like a ri-right around
a tenth of 1%, essentially zero cost, it has
to be that as a matter of logic they're going
to outperform most other managers.
And I look at this stuff I-I said you oughta
be in index funds before index funds even
existed.
I'm actually working on the tenth edition
of my book, A Random Walk Down Wall Street.
And every time I do it and these are data
that I'll put in the new edition, every time
I look at it, look at the last year, look
at the last 20 years, you see generally ? of
investors of funds are beaten by an index
fund.
And it doesn't matter whether it's a-all funds,
all large cap funds, all mid cap funds, all
small cap funds, multi-cap funds, global,
international.
Even in emerging markets, 90% of active managers
are beaten. And the reason that more are beaten
in emerging markets which are probably less
efficient is that they, the expenses of dealing
with emerging markets and the problems of
tryin' to do a lot of turnover in trading
because there are stamp taxes, they're a lot
of taxes in emerging markets, even there indexing
works even better.
When you look at a-a very long period and
I will just tell the people who can't see
the charts, what I've done here is taken a
look at every mutual fund that existed in
1970. And in 1970, there were 358 mutual funds.
There's so every mutual fund that existed.
And then I look at how they did up through
2009. And the first thing that you, people
will notice who can see the chart is there
were only 119 that are still around, from
the 358 that started.
And all I can do is plot how the 119 did.
So, these data have what we call survivorship
bias in them, because the 239 that didn't
survive I can assure you had much worse records.
Because there's kind of a, a nasty young,
a nasty secret in the mutual fund business
and that is mutual funds are normally in big
complexes. You know the Fidelity Group, the
American Funds Group.
If you have in your complex a fund that hasn't
done well, you normally kill the fund by merging
it into a fund that had a better record. So,
that's why there's a lot of survivorship bias
in this, but even with the survivorship what
it shows you is the distribution looks like
the theoretical distribution that most of
its on the negative side. And in fact, you
can count on the fingers of one hand, the
number of funds that started in 1970 that
had beaten the market by two percentage points
or more.
It's not that you can't, it's not that there
are no examples. I sometimes say, "You know
if I'd know Warren Buffett would have been
Warren Buffett, I might have said in my books
that was first published in 1973 by Berkshire
Hathaway, "forget about index funds."
And you know what? There will be some Warren
Buffetts in the future. There may be several
of them. But the problem is I don't know who
they are and I'll bet you don't know who they
are and when you try to find, them you're
much more likely to be on the negative side
of the distribution. It's like looking for
a needle in the haystack and I guess what
I'm saying is buy the low cost haystack instead.
[laughter]
Now, you always will see examples of and-and-and
the financial press loves to do that. These
funds beat the index ten times in a row. You
see this all the time.
So this, I didn't even do this chart, I picked
it up from the Wall Street Journal a year
ago. And it said there were 14 funds that
had beaten the index for 9 consecutive years
and then how many actually beat the index
the next year. And out of the 14 there was
only 1 that beat the index; 13 of the 14 did
worse than the index.
What it shows you is you can't pick a fund
by simply saying, "This manager beat the index
for a certain number of years." It doesn't
work that way. The only thing, and I've done
statistical work on this for years, the only
thing that's reliably related to fund returns
is the costs that they charge.
In the bond market area, it's exactly the
same thing. Bonds are very close to commodity
products and again ? or more of bond managers
are beaten by a bond index funds.
Now, I don't say and I don't even myself simply
have every bit of my money in index funds.
But what I do suggest one does is what professional
investors do more and more and that is at
least the core of one's portfolio, there's
enough evidence that indexing works, that
at least the core of your portfolio oughta
be in low cost index funds. And then if you
wanna buy an individual stock or take a-a-a
flyer on buying Cambodian stock, fine you
can do it with much less risk if the core
of your portfolio is indexed.
And this is what professional investors increasingly
do. Pension funds and even universities that
do a lot of private investing, to the extent
that they hold public stock they will index
the public part of it and then do the private
stuff, stuff as active.
So, let me go back to diversification again
and this'll be the last point that I will
make 'cause I do wanna leave some time for
questions.
I have suggested to you that what you want
to do is to be broadly indexed. You don't
want just one stock. And incidentally even
though you guys will all have positions in
a great stock, Google, you don't want all
of your money in Google because ev, bad things
sometimes even happen to good companies. It's
not, and-and-and your human capital is tied
up in-in Google and remember what happened
to the people who work worked for Enron; not
that Google is anything like Enron, but --
[laughter]
you can lose your, the company goes under
and you lose your livelihood and you lose
your 401k.
Or, what happened to the people at General
Motors?
So look, Google's a fine stock. I'm not saying
you shouldn't own Google, but you don't want
everything in Google.
And you don't want everything in the United
States. What we know about investing is that
people have a home country bias, they have
much too much of their money in their home
country.
For example, in France institutional, France
is 3% of the world's GDP. Institutional investors
in France have 97% of their holdings in French
securities. That's what we call the home country
bias.
The U.S. is only 40% of the world economy.
The emerging markets are growing much faster
than the developed markets.
I know that the word "China" is a dirty word
around here --
[laughter]
but the growth of China has been absolutely
unprecedented. China has grown after inflation
over the last 20 years at growth rates between
9 and 10%.
China has surpassed Japan this year as the
world's second largest economy and the Chinese
Yuan or RMB is a severely undervalued currency.
So, I wanna argue for much more diversification.
China's a very interesting story. China in
the early 1800's had about a third of the
world's GDP and then all hell broke loose.
They were beaten in two opium wars by the
British. They were invaded by Japan, in the
1900's. Japan wasn't thrown out 'till 1945.
There was a damaging civil war.
Then Mao came in and the end of the Mao years
was a so-called cultural revolution where
the universities were closed. Anybody with
any knowledge was sent out to the countryside
to be reeducated and you ended up in 1980
with China maybe between 3and 4% of the world's
GDP.
And then this remarkable man Deng Xiaopingcame
in who was everything that Mao wasn't. Mao
was an ideologue. Deng Xiaoping was an intensely
practical person. He would say, "I don't care
if the cat is black or white just as long
it catches mice. To be rich is glorious. I
don't know whether stock markets are good
or bad, but let's try them."
And you ushered in this remarkable era of
30 years of unprecedented growth. China's
never grown; no country in history has grown
as fast as China. China is probably 12% of
the world's GDP now and according to IMF estimates
will be between 15 and 20%of the world's GDP
by 2014.
Now one of the things that the reason I think
China will grow is all the growth thus far
has been in the Eastern part of the country.
The center and West are still dirt poor and
people are restless there. There's a lot of
unrest in this area. The government wants
to stay in power and so government policy
is, "We've got to keep this growth machine
going."
And China had a fiscal stimulus program. They
were the first to get out of the worldwide
recession. They had a fiscal stimulus that
was much bigger than ours relative to GDP
and they've got the wherewithal to do it.
We now have a deb- to-GDP ratio in the United
States that's getting close to a 100%. Europe's
is close to a 100%. We know what's happening
in Greece right now because people are worried
about buying Greek debt. Japan's is over 200%
of the world's GDP; debt-to-GDP is over 200%;
China's is 20%. So, they've got a very strong
fiscal balance and tremendous human capital.
The Chinese have revered education since the
time of Confucius. They are hard working.
They're entrepreneurial. They have a gambling
spirit which is I think anybody's who's gonna
be an entrepreneur has to be a bit of a gambler.
It is a growth story that I am sure will continue.
How would you access China? Well, the same
kinda story that I have suggested before for
U.S. Why not do it through index funds? And
relatively low, but not as low cost as U.S.
index funds 'cause it's more expensive to
invest abroad, but there are exchange traded
funds. The most popular one is called FXI.
It trades on the New York Stock Exchange.
It's FTSE XINHUA 25 Stock Index. It's like
the DOW of Chinese stocks available in the
international market.
I think it's much too narrow. It's 50% financial,
it's about 80% financial and oil and energy,
essentially no consumer, almost no technology.
And so the newest ETF trades under the ticker
symbol Y-A-O and I've been associated with
this through a little company called AlphaShares
that I work with out here.
YAO has 150companies. it's much more diversified.
It has some consumer stocks in it; the largest
package noodle manufacturer; sneaker manufacturer.
We've got consumer stocks; we've got technology
stock, Baidu for example, isn't in FXI and
is in YAO and Baidu's certainly been a, you
talk about things with having correlations
that are too high, Baidu's certainly has had
a good negative correlation with the stock
[chuckles] that's in, I'm sure all of your
portfolios.
[laughter]
We also have a small cap ETF. It's an index
fund, but it's small in capitalization stocks;
trades on the New York Stock Exchange under
the ticker symbol H-A-O. Low cost, relatively
low cost, and the nice thing about the small
cap is many of the larger cap companies in
China are half owned by the government. So,
when the government owns half of your stock
you don't know that they're necessarily gonna
do something that's in the interest of the
stock holders.
HAO, the small cap ETF, has much more in terms
of the more entrepreneurial and privately
owned companies where the government doesn't
own a share, and we would say that both of
those are great.
We've also got a-a technology ETF and I would
say for those of you who were wealthy enough
to have a-a large amount of money that they
want to diversify into China, we have even
lower cost separately managed accounts with
about a third of the expense ratio of the
ETF's which are also pretty low expense.
So, those were my, those were my prepared
remarks. I think we have 15 or 20, by my watch
we have at least 15 minutes for questions
and I would be delighted to try to respond
to questions.
[pause]
Oh, and if you would in asking a question
if you could move to the microphone then I
won't have to repeat the question.
[pause]
>>male in audience #1:
Hi.
>>Professor Malkiel:
Hi.
>>#1:
You talked about dollar cost averaging -
>>Professor Malkiel:
Yes.
>>#1:
In the context of like your regular savings,
but in Random Walk you were a little ambiguous
about when you have a big chunk of money to
invest, put it all in at once or spread it
out to get dollar cost averaging. Is there
a conclusion on that or is it just we don't
know?
>>Professor Malkiel:
Well, the problem is that if you looked over
history the reason for the ambiguity is that
when there is a long term uptrend to the stock
market, you can lose out by putting, by not
putting your money in earlier rather than
later. And that was the reason for the ambiguity.
Frankly, I'm less ambiguous now because of
some of the lessons that we learn from behavioral
finance. And one of the lessons is this lesson
of regret.
The problem with putting it in particularly
as markets have become more volatile, which
they have, when you put it in all at once
there is a chance that you're going to put
it in at a period like January or-or even
worse March of 2000 and you have a terrible
decade, a terrible performance, and that regret
can actually make some people say, "My God,
I don't want t-to be in the stock market at
all."
And I guess I'm less ambiguous now is it might
not always be optimal, in that the lo - I'm
a, still, I'm still not, I didn't mean to
suggest I was negative about the United States.
We've still got the most flexible economy
in the world. We are still the people who
basically invent Googles and invent iPads
and iPhones and so forth.
This is still a-a great, wonderful country
and is going to be, but because the danger
of the-the risk and the potential regret if
you do happen to get in at the high and I've
told 'ya nobody knows when that is, and the
reduction in volatility that you get and the
feeling that I and certainly some other people
have is that we probably have a good bit more
instability in our markets and volatility
today than we probably thought. We-we probably
should have realized that we had more volatility
than we did, but we got fooled because things
seemed so stable in the '80s and '90s. I think
because of that even though I understand it
might not always be optimal, at least some
of it I think oughta be a Dollar Cost Average.
And I wouldn't put it all in at once.
>>#1:
Is there any guideline about how long to spread
it out, like six months or like ten years
or depends on the amount of money?
>>Professor Malkiel:
There, I would say right now I probably wouldn't
spread it out too long because it also depends
upon what the alternative is.
If you were in a period where short term interest
rates were 10% I'd spread it out over a longer
period because your alternative might have
been to put it into a short term instrument
that paid 10%.
The problem today is that the alternative
is making zero. And so I can't tell you exactly
what it would be, but I think I'd spread it
out less now then I would if the alternatives
were better.
>>#1:
Thank you very much.
>>Professor Malkiel:
You bet.
[pause]
>>male in audience #2:
[Indian accent]
Hi, I think I read your Random Walk book about
15 years ago and I'm very happy that I did
that because I've been sort of a buy and hold
investor all along. So it's a great thing.
With respect to your presentation I think
while I completely, as I said I agree with-with
the, with the thrust of the presentation that
a couple of I would say statistical numbers
that a person that I sort of disagree with.
For example, this an often repeated thing
that if you miss the best 10 days of the first
decade then you-you're return goes way down.
That people who present that particular factor
never talks about what would happen if you
could miss the 10 worst days of the past [chuckles]
decade. I mean statistically both that are
about the same.
Another example is you presented under the
portfolio, how would you have grown over the
last decade of your Dollar Cost Average and
what I've heard, but it sort masks the fact
you had a thousand dollars going in every
month, which adds up to a hundred and thirty
thousand, so I think I see some biases in
the presentation is what I'm trying to say.
>>Professor Malkiel:
You are certainly correct that it is right
that while you would have killed your return
if you had missed the 10 best days. It's also
true that your return wouldn't have been nearly
as bad if you had missed the 10 worst days.
But there, I-I think I come back to say you
probably can't do either and would go back
to the graph showing that when you try to
do it you're more likely to be incorrect than,
than correct.
You're also right, and as a matter of fact
I'm gonna redo the graph that I showed you,
there's a bit of bias in the graph which those
of you in the other room didn't see, that
shows, "Gee you would have lost money, but
gone up from a 100,000 to 250,000 by doing
a little dollar cost averaging." You did put
a bit more money in; you put 12,000 dollars
a year more into it.
I'm gonna redo that so that you put exactly
the same amount in and it would reduce it
a little bit, but the point is still right
that you would have done a good deal more.
But you're very perceptive; there was a small
bias in it but not a huge one.
[laughter]
>>male in audience #3:
So, I have something of an abstract question
here. In the ideal world where a majority,
a majority or a plurality of individual investors
follow your advice and-and hold most of their
money in index funds, what are the consequences
for corporate governance when you have a large
class of investors holding on to voting stock
essentially just to get their share of the
potential uplift instead of to be part of
holding on, part of the company?
>>Professor Malkiel:
When you began that question I thought you
were gonna say, "What if everybody indexes?
Would it then make indexing a non-optimal
strategy?" And I often answer that when 90%
of people index I'm gonna start to be worried
about that.
But in terms of the governance question, I
think it might even improve corporate governance
for the following reason: think of, say, Vanguard
has active and passively managed funds. But
when you think of a passively managed fund
it's often said, "That when an active manager
doesn't like what corporate management is
doing, they just sell the stock."
The index fund can't do that and I would think
that it would make passive managers even better,
more interested in corporate governance; more
interested in voting their shares; more interested
in writing letters to management to look very
carefully about things they're doing that
the manager doesn't like because the manager
can't sell the stock.
So, my sense is that I think it might actually
make things even better because the active
manager will say, "Listen, I'm not gonna bother
with that I'm just gonna sell the stock."
The passive manager can't, and so the passive
manager has to take the action and my own
experience as a board member in Vanguard is
over time we spent more and more time worrying
about proxy issues and actually taking a stand.
So I think it's a, I think it's potentially
an advantage of passive management not a disadvantage.
>>#3:
Thank you.
>>male in audience #4:
Professor, I have two investment strategies
I would like to get your take on.
[laughter]
The first one if you look at Warren Buffett's
top ten stock holdings, a lot of them are
dividend based. In other words he'll hold
stocks that pay out dividends regularly.
And the second question was I wonder what
your thoughts were on the Vanguard REIT Index
Fund for the States?
>>Professor Malkiel:
O-okay, on, let me just do the second question
first. The Vanguard REIT Real, Real Estate
Investment Trust. Real estate is I think potentially
a-a very good asset class that isn't perfectly
correlated with the others.
Real estate has been a terrible place to be.
Commercial real estate has been a terrible
place to be. I think real estate right, who
knows if it's the bottom or not. But I think
it's a very good diversifier. It's something
I own in my own portfolio and I definitely,
definitely like.
On Warren Buffett, I think one thing you must
understand is that because of his size now,
Warren Buffett can do things that really other
people can't do.
I mean for example, when he put his money
into Goldman Sachs, getting a 10% coupon on
a preferred stock and scads and scads of equity
is something that wasn't available to other
people.
In fact, I wish the government in its "bale
out of the financial institutions" could have,
could have used Warren Buffett's template
to make a better deal [chuckles] with the
institutions that the government put money
into.
But Warren Buffett has very often taken such
large positions, and this gets back to the
governance issue, that he can actually help
in improving the management.
In fact, one of the earliest wonderful investments
he made was a failing company, The Washington
Post. And Katherine Graham when she heard
that Buffett had bought 10% said, "Oh my God,
he's trying to take over the company and throw
me out." He said, "No, I did it as an investment."
She then said to him, "We're in real trouble.
Please help me." And Buffet went on the Board;
helped her get a, she was an editorial person,
helped her get a good management in.
So, Buffett is almost closer to being a private
equity person and look there's no question
about it, Buffett's one of the smartest investment
people there, there is and we know that now
and there will be other Buffett's.
And as one of the satellite portfolios, if
you think you've got another Buffett, I see
no reason for doing it, but I wouldn't put
everything in that because it is, he is really
a needle in the haystack and it's much easier
to find the people who went downhill then
to find the Warren Buffett's.
>>#4:
Yeah, thank you.
[pause]
>>female in audience #1:
Hi, I have a question from the San Bruno office.
Do you recommend that your 401k portfolio
reflects the same investments as your other
general portfolio? My financial advisor recommended
that I do the exact same breakdown in both
401k and brokerage accounts.
>>Professor Malkiel:
Well, I think it really de, I think it really
depends. And I think I would say the answer
is no. And I'll tell you why because I just
did have a chance to look at the options in
the Google 401k.
And for example, I have suggested to you that
I think everybody ought to have some investments
in directly in China and I'd probably make
the same case for India; probably make the
same case for Brazil.
So, to the extent that that is not directly
in your 401k, I think you get nicely diversified
with a lot of index funds in your 401k and
then I think for your individual investments
you might very well stray from that and use
them as the kind of satellite portfolios where
you do things like take a big, or at least
a significant position in a place like China
which tends to be under represented in-in
general international index funds. And I might
just tell you why.
Index funds, international index funds are
so-called float adjusted. That is to say,
the weight of the country depends upon the
value of the floated shares.
Now what do I mean by floated shares? What
I mean is that when the government owns half
of a company what the index fund uses as a
weight is only the part that trades freely,
not the part that's owned by the government.
Another thing about China that's so peculiar,
China has currency controls. And a lot of
the Chinese equities are traded in local markets
in Shanghai and Shenzhen which are not available
to international investors. They are not part
of the float.
So, in international portfolios, China which
I suggested to you is 12 or 13% of the world's
GDP now, is probably one or one and a half
percent of the index portfolios because of
the peculiar nature of the Chinese markets
and the still significant amount of government
ownership.
So, I think you wanna look at your indices
and when there are problems where particular
countries or types of stocks get under weighted,
that doing the adjustment in your personal
portfolio makes sense.
And so I don't think you ne, I think you wanna
look at the whole portfolio together, but
I don't think that means you oughta do exactly
the same thing in your personal portfolio
that you do in your 401k portfolio.
>>female in audience #1:
Thank you.
[pause]
>>male in audience #5:
[Eastern European accent}]
Hello. Thank you for coming.
You actually just answered part of my question
which was so like in an ideal world we would
allocate our index funds globally probably
following some GDP metric or if-if the U.S.
is 40% of the world's GDP I would allocate
40% to the portfolio.
But my question was, ties into that so how-how
do we correct for what is, what is the, let's
call it a non-GDP measure and it-it doesn't
have to be a measure. I mean like the fact
that China is not really a democracy of-of
a like Western-type democracy or the fact
that the United States is running deficits
that is worsen to some.
So how, like what, what correction would you
apply into the ideal formula? Like given some
of the geo-political things going on in-in
some of these largest economies?
Thank you.
>>Professor Malkiel:
I think that's a very, I think that's a very
difficult question and I think different people
will have to answer that differently. I would
have to tell you that I think in a way there
are political risks all over the world.
I think there's a big political risk in Europe
where I am not sure that the Eurozone is sustainable.
I've always been a kind of a skeptic of this.
What you, it can work in the United States
because we have labor mobility. It can work
in the United States because we have a way
of compensating the losers.
If there's a lot of unemployment in Appalachia,
we will pay unemployment benefits. We will
have wel, we will have food stamps and so
forth. That doesn't happen in Europe. There's
no central government.
So yes, there are political problems absolutely
in China, but I would say that they are the
same kinds of things all over the world.
So, I'm not sure exactly how you would make
those adjustments and I think probably, and
I think part of it also has to be how comfortable
you feel about doing this. And it may be that
you don't feel that comfortable realizing
that the U.S. is only 40% of the world's GDP.
You might want 60% in the U.S., although I
think there are certainly political, I'm not
sure that the political stability and our
tax structure, I mean we, there's a lot of
worries in the United States.
We've made promises that given our current
tax structure we can't keep. And I think we've
got, if we don't come to terms with a lot
of this. So, I think there are risks all over
the world.
We'd probably all answer it differently and
I'm not necessarily suggesting to you that
you have to take my template of saying, "The
U.S. is 40%; only have 40% in the U.S." But
I do suggest that you think, "The U.S. is
40% of world's GDP and maybe if I look at
my 401k it's a 100% in the U.S." Then probably
one ought to at least think that we oughta
move in the direction of more of it going
overseas despite the fact that as you say
there are certainly problems.
But I do think if we looked honestly at what
we had, we'd have to say that for all of the
problems there is this home country bias and
we probably oughta look carefully and ask
whether we really are diversified enough.
>>#5: Thank you.
>>female in audience #2: Just out of curiosity
I was wondering if you had say a million dollars
in cash, how would you invest that? And if
you, if you can't name the specific percentages
maybe just some index funds that you would
suggest.
>>Professor Maliel: Well, I think again it
would depend in part, de, in part on one's
age. Let's say that you were talking about
somebody who is getting close to retirement.
I'd think I would use one of the target funds
targeted to the year at which one was planning
to retire for a significant part of it.
If I was in my 20's my sense would be where,
where my biggest asset are the earning that
I have throughout my lifetime, I would probably
think in terms of my investments of being
far more aggressive. I'd have more equities
than bonds. I would tend to be more international
despite some of the risks then less international.
And it also depends upon my temperament. Because
if it's one thing I know, I-I've become the
informal advisor to a-a number of the widow's
of faculty members at Princeton. And I really
do understand how emotions and one's capacity
to take risk is important.
There was one widow, she was only fifty years
old, her husband died very young, and she
was just so nervous and we were trying to
think of what's an optimal mix of stocks and
bonds. And normally for someone who is fifty
you'd think that at least half in stocks,
maybe more would be appropriate.
But she was just so terribly nervous we agreed
on, we agreed on one-third stocks and two-thirds
bonds. And it's now the beginning of last
year, all hell is breaking loose, and she
comes into my office in absolute tears, "I
can't take it anymore. I have to sell all
my stocks."
Now, if I were just coldly thinking of the
right thing to do I'd say, "Hey, this is the
time to rebalance; put more into the stock
[chuckles] market."
[laughter]
All I could do is keep her from selling her
stocks –
[laughter]
and-and so that's a factor as well. Some,
one's temperament is certainly a factor. The-the
old line was the, J.P. Morgan was asked by
a friend, the friend said, "Hey, look what
should I do? The stock market's going up and
down; I can't take it anymore. I can't sleep
at night. What should I do?" And J.P. Morgan
said, "Well, sell down to the sleeping point."
[laughter]
So it really is partly and-and this is partly
an emotional thing, so I think all of those
are factors. And I can't just give you one,
one answer, but I think given you some idea
of the direction in which I would put things.
[pause]
One more question, th-the hook is coming.
[laughter]
>>male in audience #6:
Thank you. In your book you talk a lot about
saving as well as an in-investing and I'm
wondering if you could give some guidance
a-as to what would be a good targets to save
maybe at different ages and percentages.
>>Professor Malkiel:
Yeah, I think for most people I would just
say more. I mean it's --
[laughter]
it-it's, I don't think preaching to you guys
I have to do because I have learned at lunch
that you now have a 401k where 99% of the
people are in.
Where I really have to do the-the-the saving
pre-preaching is so many people in so many
companies are not part of their 401k and they
save absolutely, they save absolutely nothing.
And some people don't even join the company
401k when up to the match of the company.
So I-I'm not sure that with your 401k that
you have here that this is something where
you all are doing something that's, that's
wrong.
But I think in general I would say, I would
say this: I don't think you have to save quite
as much if you start early because you've
got that compounding affect.
And where I think you really need to save
which could be 15 or 20% or even more of your
income are those people who did no saving
at all when they were young and they're now
looking at retiring in 15 years and those
folks have to save a very high percentage.
So I'd say again, I don't wanna give a particular
number, but less if you're young, more if
you're older.
And also to think and people I think don't
do this, but maybe every once in a while,
even if you don't keep a budget, to look at,
"What did I spend money on last month." And
ask yourself, "Do I really have a lot of stuff
that really didn't give me much satisfaction?
Did I need all of that stuff?"
Remembering that the opportunity cost of not
saving when you're in your 20's the opportunity
cost of not saving a dollar might be 10, 15,
20 dollars in your 50's and 60's. So, the
opportunity cost is higher when you're younger.
And you ought to at least think of those,
think of those kinds of things, but I think
you guys are --
>>female voice:
Hello, hello.
>>Professor Malkiel:
you guys are generally okay.
>>male in audience #6:
Thank you.
>>Professor Malkiel:
Okay, thank you all very, very much.
[applause]
