Our guest on the WCI podcast today is Burton Malkiel. He is the author of the best-selling book, A Random Walk Down Wall Street. He shares his decades of experience working in finance and investing and talks about his belief that the easy thing is not usually the smartest thing to do. Fortunately, that is not the case with being an above-average investor. We think you will find this conversation as educational as it is fascinating.


 

Dr. Malkiel's Early Years

We have a really special guest that I'm thrilled to have on the podcast. It is somebody that I've known about for a long, long time, and I read his book a long, long time ago. One of the first really good investing books I read back in, I don't know, 2005 maybe. I heard him again recently at the Bogleheads Conference, and I was so impressed at this 90-year-old's ability to communicate complicated ideas and to be sharp as a tack that I invited him to come on to The White Coat Investor podcast. He also happens to have the newest edition of his book out. You may not have heard of Burt before, but if not, you're really missing out. He has had a long and distinguished career and is well-known in the investing community, particularly among advocates of index fund investing.

He is a veteran. He is a professor in his seventh decade at Princeton. He has been the director of the Vanguard Group, and he spent 28 years doing that. He is also the chief investment officer at Wealthfront. He has had a long and distinguished career, but perhaps he is most well-known for a book that we're going to be talking about today called A Random Walk Down Wall Street. Burt, welcome to The White Coat Investor podcast.

“I'm delighted to be here. Thank you.”

Amazingly, I'm sure there are a few in our audience who don't know much about you. So, can we start just having you tell us a little bit about your upbringing and maybe how it influenced your views on money?

“Sure. I grew up in a tenement house as a poor kid in the Roxbury section of Boston, Massachusetts. As I said, I was a poor kid, no real interest in investing because I had no money to invest. But I liked numbers, and I was kind of fascinated with the stock pages of the newspaper and how the prices fluctuated each day. As a 10-year-old, I could tell you the price of General Motors stock as well as Ted Williams' batting average. It was something that, for some reason, as a numbers guy, interested me. In going through high school in Boston and then into college, I majored in economics. Economics was perfect for me, because there were lots of numbers and diagrams and a little bit of math at the time.

That was my upbringing. I was a pretty good economics student, and my advisors in college said, ‘You must go to graduate school, study economics, and become an economist.' At the time, I would hear nothing of it, because as I said, I grew up a poor kid. I never had my own clothes. They were all hand-me-downs from older cousins, and I didn't want to be poor. I thought since I was sort of interested in financial things that I would go to Wall Street. At the time, I actually went to business school, had a period as a finance officer in the United States Army Finance Corps, and went to work on Wall Street as an investment banker. I was fascinated by the world of finance. But as someone who is always a little bit skeptical of almost everything, I was very friendly with the research department of my firm, which was one of the leading firms on Wall Street. I wondered if the emperor really had clothes. I looked at the research recommendations and yes, they would go up for a while, but then they would go back to where they were. I thought to myself, ‘Is this really helping people?'

Fortunately, I did make some money on Wall Street, and the old thought that I ought to do a Ph.D. in economics was always in the back of my mind. I started to try to do it part-time at New York University, working on Wall Street, but I'd be traveling all over the country. There was no way I was missing three-quarters of my classes. By the time I had actually made enough money on Wall Street to think that at least I wasn't going to be poor all my life, I took a leave of absence to study economics at Princeton, New Jersey, which is where I got my Ph.D. Much to my surprise, they offered me a job teaching. At the same time, I was offered a job as a director of Prudential Insurance company, one of the biggest insurance companies in the world. I thought, ‘Hey, you know what? I can have my cake and eat it, too. I can be an academic and teach, which I enjoyed doing, and study markets, and at the same time make enough money so that I knew I would not be poor for the rest of my life.' That was how I ended up in this world of academic life and business life. I then served as a director and chairman of the finance committees for many different corporations and financial institutions, and I had this dual life that suited me very, very well for the rest of my life. I am not sorry about any of the decisions that I have made.”

The 13th edition of your best-selling A Random Walk Down Wall Street was just released on January 3. We're recording this on January 9, so it was just last week. I bought it I think the second day it was out. But this is one of the first classic investing books I ever read. It must have been close to two decades ago that I read it for the first time. I don't know what edition it was. But even back then, the book had already been a classic for decades. This is the 50th-anniversary edition of this book. Now, these days, index investing is a well-understood gospel among investors, but 50 years ago, that was not even close to the case. Bogle's 500 index fund had not even been started yet. Can you tell us about the reception to the first edition of this book?

 

The Beginning of Index Funds

“Well, as you said, it recommended index funds in the first edition and suggested that they would do even better than all the actively managed funds that were heavily advertised. The reception was pretty good in the academic community. But in the financial community, it was thought of as naive at best. Who would want to be mediocre, which was what you were going to do if you ever had an index fund that you could buy? So, the initial reaction was not good. My book was reviewed in Business Week, I remember. The review was terrible. Interestingly enough, you mentioned the first index fund, that also had a terrible first reception. Vanguard introduced the first index fund three years later after my book was published. They were going to have an initial public offering, which they hoped would have $250 million of sales. The underwriters said, ‘Well, that's too optimistic. You better cut it back to $150 million.' The underwriters then tried to sell it, and in fact, they sold only $11 million of the first index fund. It was called Bogle’s folly. It was called a horrendous mistake. I used to joke with Jack Bogle, the CEO of Vanguard, that he and I were probably the only investors in the index fund that there were.

The initial reaction was simply terrible to the idea in the book and to the actual index fund. But what's interesting is as the evidence accumulated, it's just absolutely amazing how well this worked. Standard & Poor does a study each year where they compare the results of an index fund with the results of active managers. Every year, two-thirds of active managers are outperformed by an index fund. One-third do better, but two-thirds do worse. But the problem is the one-third who do better in one year aren't the same as the one-third who do better in the next year. What happens is when you compound this over 10 or 20 years, you find that 90% of the professional active managers underperform a simple, broad-based index fund. It's not that nobody can outperform. There are 10% that, over the long poll, do outperform. But if you try to go active, you're much more likely to be in the 90% category to underperform. On average, the average professionally managed active mutual fund or exchange-traded fund underperforms a low-cost index fund by about one percentage point a year.

It's not a mediocre performance. People say who wants average performance? It's not average performance; it's above-average performance, and it's been consistently shown year after year. Frankly, I believe in the thesis that was in the initial edition of the book, even more strongly 50 years later than I did at the beginning when it was thought of as being heterodoxic. It was absolutely silly. Well, it's not silly. It actually works, and it is an above average performance. I believe even more strongly today that the core of everybody's investment portfolio ought to consist of low-cost, broad-based index funds.”

It's interesting. The data is what it is, and it's very convincing, but it's also usually pre-tax. When you look at it after-tax, it's even better, particularly for those who have most of their investments inside of a taxable brokerage account, simply because the index funds have such low turnover and are so tax efficient.

“That's absolutely right. After tax, the advantage is even more. When you have an actively managed fund and you have it in a taxable account, you'll get a 1099 form at the end of the year. They have realized a lot of capital gains because they change. They're professionals. They go into one stock, and if it does go up, they sell it. Since there's a long run-up trend for the stock market, they're recognizing capital gains. The capital gains that they recognize are typically short-term capital gains that are taxed at regular income tax rates. Whereas for broad-based index funds, there are essentially no capital gains that are realized. You even get something that is more tax-efficient than an actively managed fund. After tax, the difference is even more than one percentage point per year.”

In the book and elsewhere, you've written with regard to index fund investing, that being an above-average investor is extremely simple. It is not often in life that the easy thing to do is the smart thing to do, yet it's so hard to convince people of that truth. Why do you think it's so hard?

“I think it was hard because remember, you have got a financial community with lots of resources who are advertising and telling you, you can't do it yourself. You need our professional help to do it. So, you've got the whole financial community working on the other side to convince you that you can't do it. But the message is getting through in that today, more than half of mutual funds are indexed. Now that we have mutual funds that are indexed and so-called exchange-traded funds—funds that sell on the exchanges and that you can buy through your broker—these are typically index funds.

It was hard to get the message across, but it is getting across. And now some people are saying there's too much indexing, and they're worried about that. So eventually it does get across, despite all the advertisements on the other side. As you said, it is the right advice. It is the advice that has helped people. In one sense, I think one of the things that's so wonderful about being a doctor, when you can feel that someone has come to you with a disease or an illness and you have been able to help them, I am sure it's a marvelous feeling. For me in writing this book, I think the greatest joy is when I get letters from people who say, ‘I bought the fourth edition of your book or something a long time ago. I did exactly what you said. I've never had a lot of money, but I consistently put some money into a broad-based index fund. I now look at my retirement fund. While I never earned a lot of money as a worker, I find I now can have a comfortable retirement.' I think it's that that gives me the kind of pleasure that I'm sure doctors have when they have been able to really help people.”

Do you get more pleasure from that, or do you get more pleasure from the fact that Fortune calls you the man mutual fund managers hate?

“Well, I guess, with a little smile, I can say that does please me, but I really do get more pleasure out of thinking that really what time has shown is that it is the right advice and that people have actually been helped by it.”

More information here:

10 Reasons I Invest in Index Funds

Happy Anniversary to the Index Fund—Which, by the Way, Was NOT Invented by Jack Bogle

 

What Is Different in This Edition of A Random Walk Down Wall Street? 

Thirteen editions now. Why has it been so important to you to keep this book updated every few years, and what can readers who might have read the sixth, or seventh, or eighth edition expect to find new in this 50th-anniversary edition?

“In one sense, it hasn't changed at all in that it believes in index funds as the core of a portfolio. But what has changed is the way that you can do it. This is an investment guide. And remember, as we just discussed, there were no index funds when the book first came out. In fact, so much of what we are able to do today didn't exist at the time the first edition came out.

There were no money market funds. There were no bond funds. There were no bond index funds. There were no tax-exempt funds for people who hold some assets outside of their retirement plans. The whole idea of what you can do with your retirement plans is different. There were no Roth IRAs. There were no 529 college savings plans where you could help your children with college expenses or your grandchildren. All of the instruments that are now available. When you look at the practical advice of exactly what it is that you should buy, these things have changed enormously. Each new edition talks about what are the optimal ones today. Incidentally, the other thing that's happened is that competition has driven the cost of these index funds down to essentially zero. That has been a big change.

The other thing that's changed is the following: with investing, you're right, the simple thing is the best thing. But one of the problems with investing is that we are sometimes our own worst enemies. One of the new things, for example, in the book is a whole new chapter on behavioral finance. And what are the errors? How are the ways we shoot ourselves in the foot? If I can make an analogy to medicine, the doctor might say, ‘Look, having this double cheeseburger and fries for lunch every day probably isn't the healthiest thing that you ought to do for your long-run health.' But some of the things that we do as individuals, we get over-optimistic. We then go and say we're going to follow some trend. We're going to follow something that's new. We're going to get into Bitcoin. Bitcoin is the currency of the future. There's this speculative craze, and it goes to $70,000. We get whooped into this and we say, ‘My God, I'm going to sell my index fund and buy into Bitcoin.' Or we've recently had so-called meme stocks, this stock GameStop is doubling and then doubling again. Or we've got the ARKK Innovation Fund.

A couple of years ago, people were saying, ‘What are you talking about? Why should you be in a simple index fund?' This fund just made 150% in the last year by buying new technology stocks. Let's put everything into Tesla because this is the way all automobiles are going to be in the future. Those are the mistakes that can kill an investment portfolio. A lot of what's in new editions is the warnings about these kinds of things. Incidentally, this ARKK Innovation Fund, which a year and a half ago sold at $150 is now selling at $30. So, avoiding mistakes is the second most important thing.

The other thing is people have been fascinated with so-called ESG investing. Is there a way of doing good for humanity and doing well financially? That's what the advertisements say. Does it, in fact, work? What we've done in new editions is talk about what people are talking about in investing now and does it work or doesn't it work? Factor investing. A whole bunch of things that are very popular in the financial community, getting people up to date with what financial advisors are talking about and separating the wheat from the chaff, what you might listen to and what you shouldn't.”

Things have certainly changed in the last 50 years, and I don't know if people would keep reading the first edition and get the important message out of it if it hadn't been updated and didn't discuss some of those things. One of the concepts that I believe was in the first edition is the concept of the blindfolded chimpanzee. Most of us have heard this idea. The blindfolded chimpanzee throwing darts at a page of the Wall Street Journal can pick stocks better than an active fund manager. Interestingly enough, the Wall Street Journal actually ran a series for a while demonstrating that that was actually true. But most people may not realize that concept, I believe, came from the first edition of your book. Where did that idea come from, of the blindfolded chimpanzee?

“So many people tell me that they studied economics for a while in college and found it so boring that they never continued with it. One of the things I've always tried to do as a teacher is to try to make it as interesting as possible, using the right analogy, using the story that people can relate to that makes the point. I had done this with the chimpanzee throwing darts at the Wall Street Journal. The Journal did run the contest. They let me throw out the first darts. Now, I wasn't really serious about the fact that you ought to select your portfolio by throwing darts. The right analogy is probably to throw a towel over the stock pages because I want you to buy and hold everything.

But the chimpanzee was something that people could relate to. It was interesting and that was in the first edition and it helped cement the point. Really, the thing I've tried to do in the book is always to make it interesting. There are little stories throughout that I hope people will find interesting. If you thought that finance or economics was boring, I hope the people who look at the book will say it's actually fun to read.”

 

Efficient Markets Hypothesis 

Let's talk for a minute about the efficient markets hypothesis. Why do people assume that because markets are not perfectly efficient, we should not act as if they were?

“The analogy that I would use is the following. If you were talking about an engine, you're an engineer talking about an engine, would you ever say an engine was perfectly efficient? No. You'd say, relative to some ideal, the engine is 90% efficient or 85% efficient. The market's not perfectly efficient. The market makes mistakes. Sometimes, it makes doozies of mistakes. For example, there are bubbles in the market. In January 2000, all the high-tech stocks were selling for more than 100 times earnings. A normal earnings multiple is 15 or 17. And there was clearly a bubble. Some people would say, ‘Well, that proves to you that markets are inefficient, and you should never believe in the efficient market hypothesis, as it was called.'

I write about this. There's no question. The market went absolutely crazy. But here's the thing. The difficulty is there was no way to know in advance when the market had hit bubble levels and how much the bubble was going to inflate. Now, people forget. It was Alan Greenspan, who at the time was the head of the Central Bank, the Federal Reserve, who coined the expression irrational exuberance. In talking about that, it was called the internet bubble or the dot-com bubble. Stocks that added dot-com to their name would go up a lot, because this was the way that you ought to invest. You don't want a broad-based index fund. You want to just be in the dot-com stocks. Alan Greenspan was the one who coined that expression. But what people forget is that he coined that expression in 1996. If you had simply bought a broad-based index fund in 1996, held it through the bubble and then held it later, you did extremely well making about 10% a year. If, in fact, you had instead bought these dot-com stocks, at the time, you would've been really killed financially.

The darling of the market at the time was a stock called Cisco Systems. Still exists. It makes the switches, and it's called the backbone of the internet. Well, even today, Cisco Systems is selling for only about half of what it sold for in January 2000. So, yes, there are bubbles. But trying to go and be smart, and I will then be able to avoid them, I'll just be out of the market at that time. It doesn't work because you have to know what you can know and what you can't know. There was no way that anybody could do this with any kind of accuracy.

Recently, I had mentioned GameStop. There was this bubble in so-called meme stocks where, particularly with the internet, everyone thought that this was the way to get wealthy. The stock doubled and then doubled again. You could think, ‘Smart people would know better, and they would be able to sell the stock short.' There was a hedge fund called Melvin Capital that sold GameStop short, and the hedge fund went bankrupt because they sold it short too soon. These crazy things happen, but you're better off acting as if you'll never know when you have a bubble and when it's going to pop and how much it's going to inflate. You're still much better off assuming you can't do better than simply buying and holding a broad-based, low-cost index fund.”

More information here:

Top 8 Investing Lessons from the Bogleheads

 

Can You Have Any Digital Assets in an Intelligent Portfolio?

Now, we know how you feel about individual stocks. Do you think there is a place in an intelligent portfolio for digital assets of any kind, whether they're cryptocurrency or some other type of crypto asset, or an NFT? Is there a place for that in an intelligent portfolio?

“Look, anybody who has studied the stock market for his entire life obviously has some bit of a gambling instinct. I don't mind if you buy some individual stocks. If the core of your retirement portfolio is indexed and you want to take a flyer on an individual stock, I think that's absolutely fine. Go do it. Do it only as an add-on to your retirement fund being in a good broad-based index fund. Now, having said that, no, I would not buy any cryptocurrency. I wouldn't buy Bitcoin. I wouldn't buy Dogecoin. I wouldn't buy Ethereum. I wouldn't buy any of those. No, I would not buy an NFT. I would not bid on the people, the artist who sold for almost $100,000 his art NFT. I think this is all absolutely crazy.

Yes, buy individual assets in real companies. I don't think these digital assets are ever going to work. Let me just talk about that for a moment, because people think now that Bitcoin has gone down to $16,000, this is what you ought to buy and that it's going to go back up. It could, it could go back up. Is Bitcoin useful as a currency? Well, I don't think if I want to go to Starbucks and get my coffee that a currency that can be up or down 10% in a day is very useful. Would it be useful for something? Yes. I think if I wanted to do something illicit, if I wanted to buy some drugs, maybe I would love to have Bitcoin. That, of course, is the reason why it can never last for a long time. To the extent that it is useful, it's useful for doing sketchy things. It's useful for doing illegal things, and governments are undoubtedly in the future going to clamp down on it.

Now, I'm not a Luddite. The international payment system will improve over time. I wouldn't be a bit surprised if we have a digital dollar at some point. It's not that there won't be improvements, but Bitcoin itself, I think will never be it, nor will the other digital currencies. I say avoid them and avoid all of these things that are going to be the wave of the future because those are often the things that will lead you to disaster as an investor.”

More information here:

What’s the Future of Cryptocurrency? These Fanatics Say It’s Pretty Darn Bright

Why I’m Still Buying Crypto

 

Portfolio Construction Techniques

Turning the page to a different subject, I enjoyed the section of the book on new portfolio construction techniques. It talks about factor investing and risk parity and ESG investing. A lot of times when these new ideas come out every few years, there's good academic evidence for them. A lot of it is just backtesting, but there's good evidence. How can we determine when to listen to an academic on topics like these and when not to? How can we know if it really is different this time?

“It's a very good question. One of the difficulties with a lot of the academic studies that I've pointed out in the book is these things work brilliantly in a backtest. But do they work in an X sample period, i.e., do they work well in a period after the backtest? Very often, they don't. This is what I have tried to show. Probably the most popular right now because there's a big company, BlackRock, that has been suggesting this, that you can do good and do well financially at the same time. I'm particularly skeptical about this. Skeptical because I'm not even sure that the companies that are in these so-called ESG funds are really that good.

There are rating agencies who rate companies as to whether they're good for humanity, whether they have good governance, and so forth. And they disagree completely. In fact, the correlation between the raters is as low as 0.4. Just to put that in perspective, the correlation between Moody’s and Standard & Poor's on bond ratings is 0.995. There's almost no agreement, and there's a good reason why there's no agreement. Let's take a Midwest utility called Xcel Energy. It gets a terrible ESG rating from some of the raters, because they burn coal. But this is a utility that has promised by a date certain to be completely carbon-free. This is a utility that's doing more investing in wind and solar power than any other one. So, is it good because of its investments or bad because it's burning coal now?

Let's take another example. A natural gas company, is natural gas a bad company because it's carbon, or is it a good company because in going toward a carbon-free world that we all would love to see, natural gas is the cleanest burning carbon and we're going to need natural gas over this period. What worries me about ESG is when I look at the companies in an ESG portfolio, I wonder whether the companies that are in there are really as pure as they are supposed to be. Are they really good companies? Should I really feel good about owning Facebook or now it's called Meta or Visa? These are the companies that are often in these ESG portfolios because they don't do any polluting. But is our social media an unambiguously good thing for society? I'm not so sure. Visa, that charges exorbitant rates like 20% to poor people who've gone over the limit in their credit cards, is this a good company?

All I want people to do is to think about people who will advertise this is the best thing to do. Be very, very careful about it because, in fact, you don't outperform an index fund. In fact, you do worse than an index fund. You may neither do good for society nor well financially. Now look, a lot of people would like to feel good about their investments, and I said before, I don't mind you buying some individual stocks. Buy an index fund for the core of your portfolio, and then you want to go and buy a company that makes wind power, fine. Good. Go do it. You want to buy a solar panel company, fine, go do it. But buy it as an add-on to your portfolio, not as your whole portfolio. Because if you do that, I'm convinced you will certainly not do well financially. On some of these ESG funds, I'm not even sure that you're doing wonderful things for society either.”

More Information Here:

How to Build an Investment Portfolio for Long-Term Success

 

Dr. Malkiel's Controversial Ideas

The main ideas in your book, although they were controversial when they were first published, no longer really are. I'm going to turn to a few of your ideas that perhaps are a little more controversial and ask you to defend them. The first is using dividend-paying stocks as a bond substitute for part of a bond portfolio. The appeal is that stock dividend yields may be just as high as bond yields when interest rates are low, and you may get appreciation, too. The downside is that you're still taking on equity risk with what is supposed to be the safe portion of your portfolio. What are your current thoughts on the topic?

“Again, it's a very good question. How thoughts can change as markets change. We've had a remarkable change in our bond markets really over the last 18 months. When I had suggested bond substitutes, we basically had zero interest rates. When you have zero interest rates, bonds are particularly risky as has been shown because bond portfolios have gone down during 2022, which was a terrible year for all financial assets. But the bonds didn't protect you. I think that, in fact, dividend-paying stocks were at least as good and probably even a little better. So, did I believe in it then? Absolutely. Do I believe in it as much today? The answer is no. I believe in it less today, because today I can buy a one-year Treasury bill at over 4%. I can buy a two-year Treasury for over 4%.

What I would say today is that they are a much better investment than they were. The clear message about the stock alternatives was to do this during a period when interest rates were extraordinarily low. When interest rates have then risen, as they have remarkably over the last year, then you don't have to do that. The advice was to do it only when interest rates were essentially zero.”

The second idea I want to push back a little bit on is the idea of overweighting emerging markets, frontier markets. China, in particular, you seem to have been a fan of the last few years. Do you think investors should overweight emerging markets in China in particular?

“The idea was not really to necessarily overweight them, but for people who generally had zero in these emerging markets, they should make sure that they have some of their assets in them. I definitely think they should continue to do that. It's partly because of the demography. We in the West are aging rapidly. The work-age population is not increasing, and our growth rates are going to be a lot lower. The places in the world where the growth rates are high and where the workforce is increasing so that growth can continue are the emerging markets of the world. The fastest-growing economy in the world today is India. India is the fastest-growing economy in the world, in part, because the population is young and the population is growing quickly. Vietnam, Indonesia, these are the places where you have young populations and the populations are growing rapidly.

So yes, I think you ought to have some parts of your portfolio in these emerging markets. By overweighting, I don't really mean overweighting relative to, I don't want you to put your whole portfolio into these areas. But I certainly want you to have part of it. Let's talk about China, though. China, I am somewhat less enthusiastic about than I was in earlier editions of the book. I'm less enthusiastic because Xi Jinping, the leader of China, is much more like Mao the dictator than like Deng Xiaoping, who was the one who reintroduced capitalism into China and was responsible for the big growth rate. I'm less enthusiastic about China, because I am not particularly happy with the way government policy has changed. Would I avoid China completely? No, because it's very, very cheap. But clearly, I would have to agree with you that I am not going to beat the drums for China. If you decided you didn't want to be in China because you really didn't like Xi Jinping, I would say fine. But don't avoid India. Don't avoid Indonesia because you're going to have much more growth there because the demography is so much better.”

As much as half of investment dollars are now in indexed investments. What percentage of the market do you think can be indexed before it becomes a problem?

“I don't think we have enough indexing. Not that we have too much. If we had 95% of the market indexed, there would still be enough active people to make sure that information gets reflected in prices. And the paradox of the so-called efficient market hypothesis is you obviously do need some actively managed participants to make sure that when the drug company finds this new drug for cancer, it's now worth double what it was before that the price adjusts. I think, if you had even 1% of the market, there'd be enough people like that. But just think also as a thought experiment: suppose we were 100% indexed and there is nobody who was going and doing that. The drug company has the cure for cancer. It's going to be worth double what it was, and it doesn't move. In our free capitalist society, I can't believe that somebody isn't going to go, there's some hedge fund guy who's not going to go into the market and go and buy up that drug company and buy up that drug company until its price reflects the new information.

I'm not worried as some people are that we have too much indexing. I don't think we have enough. I will never be worried that in our capitalist economy where there's freedom to enter the market, that there won't be somebody who comes in to make sure that information gets reasonably reflected in the price of stocks.”

 

Make the Core of Your Portfolio Indexed 

Our time is now short, but this is going to be listened to eventually by 45,000 or 50,000+ high earners, mostly doctors. What have we not yet talked about today that you think they should know?

“Again, I think we touched on this, but I would say the lessons that I hope people take from this is that even if you agreed with my hypothesis about index funds, where the evidence I believe is overwhelming, that at least make sure that the core of your portfolio is indexed. Look at the lessons that have been spelled out of the bubbles that we have and seem to consistently have and how easy it is to be swept up in these bubbles, to read about them. Be very, very careful because good investing is first of all to do the right thing. But perhaps even more important, to realize that we're like Pogo, we sometimes are our own worst enemy, to avoid the really stupid things that we do that can ruin any investment plan.”

It has been wonderful talking with you, Burt. It is great to have you on the podcast. Those who would like to read some more of Burt's writings, get to know him a little more, I recommend the 50th-anniversary edition of A Random Walk Down Wall Street. It just came out in January. It's completely updated. Talks about all kinds of new-fangled stuff, ESG investing, the meme stock mini bubble, cryptocurrency mini bubble, those sorts of things, all in the book.

It's a great personal finance book, but with a heavy focus on investing to reach your goals in an easy reproducible way, as he mentioned, by putting the bulk of your portfolio into broad-based low-cost index funds. Thank you so much for coming on The White Coat Investor podcast.

“Thank you. I've really enjoyed it. I really appreciate it.”

That was great. Burton Malkiel, A Random Walk Down Wall Street. The man was born in 1932. He talks about not wanting to be poor at the beginning of the interview. In 1932, everybody was poor. He was in high school going through World War II. He served in the Army in the '50s. He's been a professor at Princeton since 1958. This is his seventh decade as an economic professor and still sharp as a tack. I hope my career goes that well, that I'm as excited about what I'm doing at 90 as I am now and that my mind is as sharp as his is at that age.

 

Laurel Road is committed to serving the financial needs of doctors, including helping you get the home of your dreams. Laurel Road’s Physician Mortgage is a home loan exclusively for physicians and dentists featuring up to 100% financing on loans of $1 million or less. These loans have fewer restrictions than conventional mortgages and recognize the lender’s trust in medical professionals’ creditworthiness and earning potential. Borrowers can also get up to $650 off closing costs! For terms and conditions, please visit www.laurelroad.com/wci. See disclaimers here.

 

Surveys for Money 

As a white coat, you have valuable knowledge. Various companies want that knowledge. And they’re willing to pay you for it! That’s why we’ve put together a list of recommendations for companies who pay you to take surveys. If you’re looking for a profitable side gig for not too much effort, getting paid for surveys could be the perfect solution for you. You can make extra money, start a solo 401(k), and use your medical knowledge to impact new products. Sign up today and use a fraction of your downtime to make extra cash! Go to whitecoatinvestor.com/MDSurveys.

 

Milestone to Millionaire 

#106 — ER Doc Becomes a Millionaire Only 3 Years Out of Training

This is our first Milestones to Millionaire guest to come on the podcast twice! First, we celebrated him paying off his student loans, and he is back again to celebrate becoming a millionaire. This doc has gotten pretty heavily involved in passive real estate syndications, and it has served his portfolio well. He is a finance enthusiast and loves to self-manage his portfolio. His advice to you? Get educated, throw your money into VTSAX or a simple 3-fund portfolio, minimize your spending, maximize your saving, and let compound interest do the rest!


Sponsor: SoFi

 

Full Transcript

Transcription – WCI – 303

Intro:
This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.

Dr. Jim Dahle:
This is White Coat Investor episode number 303 sponsored by Laurel Road for Doctors.

Dr. Jim Dahle:
Laurel Road is committed to serving the financial needs of doctors, including helping you get the home of your dreams. Laurel Road's Physician Mortgage is a home loan exclusively for physicians and dentists featuring up to 100% financing on loans of a million dollars or less.

Dr. Jim Dahle:
These loans have fewer restrictions than conventional mortgages, and recognize the lender's trust in medical professionals credit worthiness and earning potential. Borrowers can also get up to $650 off closing costs.

Dr. Jim Dahle:
For terms and conditions, visit www.laurelroad.com/wci. Laurel Road is a brand of KeyBank N.A. and an equal housing lender, NMLS #399797.

Dr. Jim Dahle:
All right. Welcome back to the podcast. This is the first one we've recorded in the new year. You are not hearing this till February, but it's the first one we recorded after the New Year, and so, it's exciting to be new year, new you. Thinking about New Year's resolutions and those sorts of things. We'll see how well I've done on them come February 23rd.

Dr. Jim Dahle:
I just got off the phone last night with my climbing partner and we're making big plans to go to the Valley this summer. We're going to go try to climb the Face of Half Dome. So, my resolution is to get in good enough shape to be able to do that. Wish me luck with that.

Dr. Jim Dahle:
Our quote of the day today comes from Carlos Slim Helu who said, “Courage taught me no matter how bad a crisis gets, any sound investment will eventually pay off.” There's a lot of truth to that. If you just pick good investments and hold on to them long enough, it's going to work out.

Dr. Jim Dahle:
Thanks for all of you out there doing what you do. It's been a wild winter in the emergency department for me. Our volumes are way up. We're seeing the triple pandemic with flu and RSV and COVID all combined, but not too bad. Doesn't feel like the depths of the pandemic by any means, but certainly very, very busy in the department.

Dr. Jim Dahle:
And so, I know those of you out there, whatever you do, whether you're a doc or not, it's the middle of winter, work is hard and you're not always very appreciated. So, if nobody said thanks, let me be the first.

Dr. Jim Dahle:
By the way, we have surveys that you can use to make money. If you go to the WCI recommended page, White Coat Investor, go to recommended, scroll down, Paid Surveys is what it's labelled. You can make money there. You can make money while watching TV in the evening and vegging. You can make money while you're on your commute, as long as you're not driving.

Dr. Jim Dahle:
You can get a little bit of side income so that you can have business income and open up a solo 401(k). Most of us can use a little bit of extra income, and this is one way that you can do it. In some specialties, this can be very lucrative. If you prescribe expensive drugs, you're probably in one of those specialties. So, keep that in mind. They'll take anybody, but they particularly want those specialties. If you go through the links on the WCI recommended page, there are some special deals available there, so check that out.

Dr. Jim Dahle:
We have a really special guest that I'm thrilled to have on the podcast. It is somebody that I've known about for a long, long time. Read his book a long, long time ago. One of the first really good investing books I read back in, I don't know, 2005 maybe.

Dr. Jim Dahle:
And I heard him again recently at the Bogleheads Conference and was so impressed at this 90-year-old's ability to communicate complicated ideas and to be sharp as a tack, and invited him to come on to the White Coat Investor podcast. He also happens to have the newest edition of his book out. Let's bring him on the podcast and let you get to know him as I have.

Dr. Jim Dahle:
Our guest today on the White Coat Investor podcast is Dr. Burton Malkiel. Now, you may not have heard of Burt before, but if not, you're really missing out. He has had a long and distinguished career and is well known in the investing community, particularly among advocates of index fund investing.

Dr. Jim Dahle:
He is a veteran. He is a professor in his 7th decade, I believe, at Princeton, as a professor there. He has been the director of the Vanguard Group. Spent 28 years doing that. He is also the Chief Investment Officer at Wealthfront. He has had a long and distinguished career, but perhaps he is most well-known for a book that we're going to be talking about today called A Random Walk Down Wall Street. Burt, welcome to the White Coat Investor podcast.

Dr. Burton Malkiel:
I'm delighted to be here. Thank you.

Dr. Jim Dahle:
Amazingly, I'm sure there are a few in our audience who don't know much about you. So, can we start just having you tell us a little bit about your upbringing and maybe how it influenced your views on money?

Dr. Burton Malkiel:
Sure. I grew up in a tenement house as a poor kid in the Roxbury section of Boston, Massachusetts. As I said, I was a poor kid, no real interest in investing because I had no money to invest. But I liked numbers and I was kind of fascinated with the stock pages of the newspaper and how the prices fluctuated each day. And as a 10-year-old, I could tell you the price of General Motors stock as well as Ted Williams batting average.

Dr. Burton Malkiel:
So, it was something that, for some reason, as a numbers guy, interested me. And in going through high school and Boston and then into college, I majored in economics. And economics was perfect for me because there were lots of numbers and diagrams and a little bit of math at the time.

Dr. Burton Malkiel:
That was kind of my upbringing. I was a pretty good economic student, and my advisors in college said, “You must go to graduate school, study economics, and become an economist.” And at the time, I would hear nothing of it, because as I said, I grew up a poor kid. Never had my own clothes. They were all hand-me-downs from older cousins, and I didn't want to be poor.

Dr. Burton Malkiel:
And I thought since I was sort of interested in financial things what I would do would be to go to Wall Street. And at the time, I actually went to business school, had a period as a finance officer in the United States Army Finance Corps, and went to work on Wall Street as an investment banker for a period of time.

Dr. Burton Malkiel:
I was fascinated by the world of finance. But as someone who is always a little bit skeptical of almost everything, I was very friendly with the research department of my firm, which was one of the leading firms in Wall Street. And I wondered does the emperor really have clothes. I looked at the research recommendations and yes, they would go up for a while, but then they would go back to where they were. And I thought to myself, “Is this really helping people?”

Dr. Burton Malkiel:
And fortunately, I did make some money on Wall Street, and the old thought that I ought to do a PhD in economics was always on the back of my mind. I started to try to do it part-time at New York University, working in Wall Street, but I'd be travelling all over the country. There was no way I was missing three-quarters of my classes.

Dr. Burton Malkiel:
And by the time I had actually made enough money on Wall Street to think that, well, at least I wasn't going to be poor all my life, I took a leave of absence to study economics at Princeton, New Jersey, which is where I got my PhD. Much to my surprise, they offered me a job teaching. And at the same time, I was offered a job as a director of Prudential Insurance company, one of the biggest insurance companies in the world. And I thought, “Hey, you know what? I can have my cake and eat it too. I can be an academic, teach, which I enjoyed doing, study markets, and at the same time make enough money so that I knew I would not be poor for the rest of my life.”

Dr. Burton Malkiel:
That was kind of how I ended up in this world of academic life and business life. I then served as a director and chairman of the finance committees for many different corporations and financial institutions, and had this kind of dual life that suited me very, very well for the rest of my life and not sorry about any of the decisions that I have made.

Dr. Jim Dahle:
Now, the 13th edition of your best-selling “A Random Walk Down Wall Street” was just released on January 3rd. We're recording this on January 9th, so it was just last week. I bought it I think the second day it was out. But this is one of the first classic investing books I ever read. It must have been close to two decades ago that I read it the first time. I don't know what edition it was. But even back then, the book had already been a classic for decades.

Dr. Jim Dahle:
This is the 50th-anniversary edition of this book. Now, these days, index investing is a well understood gospel among investors, but 50 years ago, that was not even close to the case. Bogle's 500 index fund had not even been started yet. Can you tell us about the reception to the first edition of this book?

Dr. Burton Malkiel:
Well, as you said, it recommended index funds in the first edition, and suggested that they would do even better than all the actively managed funds that were heavily advertised. And the reception was pretty good in the academic community, but in the financial community, it was thought of as naive at best, and just did wrong for the most part, that who would want to be mediocre, which was what you were going to do if you ever had an index fund that you could buy. So, the initial reaction was not good. My book was reviewed in Business Week, I remember. And the review was terrible.

Dr. Burton Malkiel:
And interestingly enough, you mentioned the first index fund, that also had a terrible first reception. Vanguard introduced the first index fund three years later after my book was published. And they were going to have an initial public offering, which they hoped would have $250 million of sales. The underwriters said, “Well, that's too optimistic. You better cut it back to $150 million.”

Dr. Burton Malkiel:
The underwriters then tried to sell it, and in fact, they sold only $11 million of the first index fund. It was called Bogle’s folly. It was called a Horrendous Mistake. And I used to joke with Jack Bogle, the CEO of Vanguard, that he and I were probably the only investors in the index fund that there were.

Dr. Burton Malkiel:
So, the initial reaction was simply terrible to the idea in the book and to the actual index fund. But what's interesting is as the evidence accumulated, it's just absolutely amazing how well this worked. Standard & Poor does a study each year where they compare the results of an index fund with the results of active managers. And every year, two-thirds of active managers are outperformed by an index fund. One-third do better, but two-thirds do worse.

Dr. Burton Malkiel:
But the problem is the one-third who do better in one year aren't the same as the one-third who do better in the next year. So what happens is when you compound this over 10 or 20 years, you find that 90% of the professional active managers underperform a simple, broad-based index fund.

Dr. Burton Malkiel:
It's not that nobody can outperform. There are 10% that over the long poll do outperform. But if you try to go active, you're much more likely to be in the 90% category to underperform. And on average, the average professionally managed active mutual fund or exchange-traded fund underperforms a low-cost index fund by about one percentage point a year.

Dr. Burton Malkiel:
So, it's not a mediocre performance. People say who wants average performance? It's not average performance, it's above-average performance, and it's been consistently shown year after year. And frankly, I believe in the thesis that was in the initial edition of the book, even more strongly 50 years later than I did at the beginning when it was thought of being heterodoxic, it was absolutely silly. Well, it's not silly. It actually works, and it is an above average performance. And I believe even more strongly today that the core of everybody's investment portfolio ought to consist of low-cost broad-based index funds.

Dr. Jim Dahle:
It's interesting. The data is what it is, and it's very convincing, but it's also usually pre-tax. When you look at it after-tax, it's even better, particularly for those who have most of their investments inside of a taxable brokerage account, simply because the index funds have such low turnover and are so tax efficient.

Dr. Burton Malkiel:
That's absolutely right. And after tax, the advantage is even more. When you have an actively managed fund and you have it on a taxable account, you'll get a 1099 form at the end of the year. And they have recognized a lot of capital gains because they change, they're professionals. They go into one stock, and if it does go up they sell it. And since there's a long run-up trend for the stock market, they're recognizing capital gains.

Dr. Burton Malkiel:
The capital gains that they recognize are typically short-term capital gains that are taxed at regular income tax rates. Whereas for broad-based index funds, there are essentially no capital gains that are realized. And so, you even get something that is more tax efficient than an actively managed fund. So, after tax, the difference is even more than one percentage point per year.

Dr. Jim Dahle:
In the book and elsewhere, you've written with regards to index fund investing, that being an above-average investor is extremely simple. It is not often in life that the easy thing to do is the smart thing to do, yet that's so hard to convince people of that truth. Why do you think it's so hard?

Dr. Burton Malkiel:
Well, I think it was hard because remember, you have got a financial community with lots of resources who are advertising and telling you, you can't do it yourself. You need our professional help to do it. So, you've got the whole financial community working on the other side to convince you that you can't do it. But the message is getting through in that today more than half of mutual funds are indexed.

Dr. Burton Malkiel:
Now that we have mutual funds that are indexed and so-called exchange-traded funds, funds that sell on the exchanges and that you can buy through your broker, these are typically index funds.

Dr. Burton Malkiel:
So, it was hard to get the message across, but it is getting across. And now some people are saying there's too much indexing, and they're worried about that. So eventually it does get across, despite all the advertisements on the other side.

Dr. Burton Malkiel:
And as you said, it is the right advice. It is the advice that has helped people. And in one sense, I think one of the things that's so wonderful about being a doctor, when you can feel that someone has come to you with a disease or an illness and you have been able to help them, I am sure it's a marvelous feeling.

Dr. Burton Malkiel:
And for me in writing this book, I think the greatest joy is when I get letters from people who say, “I bought the 4th edition of your book or something a long time ago. I did exactly what you said. I've never had a lot of money, but I consistently put some money into a broad-based index fund. And I now look at my retirement fund. And while I never earned a lot of money as a worker, I find I now can have a comfortable retirement.” I think it's that that gives me the kind of pleasure that I'm sure doctors have when they have been able to really help people.

Dr. Jim Dahle:
Do you get more pleasure from that, or do you get more pleasure from the fact that Fortune calls you the man mutual fund managers hate?

Dr. Burton Malkiel:
Well, I guess, with a little smile, I can say that that does please me, but I really do get more pleasure out of the fact that thinking that really what time has shown is that it is the right advice and that people have actually been helped by it.

Dr. Jim Dahle:
Yeah. 13 editions now. Why has it been so important to you to keep this book updated every few years, and what can readers who might have read the 6th, or 7th, or 8th edition expect to find new in this 50th-anniversary edition?

Dr. Burton Malkiel:
Sure. In one sense, it hasn't changed at all in that it believes in index funds as the core of a portfolio. But what has changed is the way that you can do it. This is an investment guide. And remember, as we just discussed, there were no index funds when the book first came out. In fact, so much of what we are able to do today didn't exist at the time the first edition came out.

Dr. Burton Malkiel:
There were no money market funds. There were no bond funds. There were no bond index funds. There were no tax-exempt funds for people who hold some assets outside of their retirement plans. The whole idea of what you can do with your retirement plans is different. There were no Roth IRAs. There were no 529 college savings plans where you could help your children with college expenses or your grandchildren.

Dr. Burton Malkiel:
So, all of the instruments that are available are now available. And when you look at the practical advice of exactly what it is that you should buy, these things have changed enormously. And each new addition talks about what are the optimal ones today. Incidentally, the other thing that's happened is that competition has driven the cost of these index funds down to essentially zero. So that has been a big change.

Dr. Burton Malkiel:
The other thing that's changed is the following, that with investing, you're right, the simple thing is the best thing. But one of the problems with investing is that we are sometimes our own worst enemies. And one of the new things, for example, in the book, is a whole new chapter on behavioral finance. And what are the errors? How are the ways we shoot ourselves in the foot? If I can make an analogy to medicine, the doctor might say, “Look, having this double cheeseburger and fries for lunch every day probably isn't the healthiest thing that you ought to do for your long run health.”

Dr. Burton Malkiel:
But some of the things that we do as individuals, we get over-optimistic. We then go and say we're going to follow some trend. We're going to follow something that's new. We're going to get into Bitcoin. Bitcoin is the currency of the future. And there's this speculative craze, and it goes to $70,000. And we get whooped into this and we say, “My God, I'm going to sell my index fund and buy into Bitcoin.” Or we've recently had so-called meme stocks, this stock GameStop is doubling and then doubling again. Or we've got the ARK Innovation Fund.

Dr. Burton Malkiel:
And a couple of years ago, people were saying, “What are you talking about? Why should you be in a simple index fund?” This fund just made 150% in the last year by buying new technology stocks, by buying, let's put everything into Tesla because this is the way all automobiles are going to be in the future.

Dr. Burton Malkiel:
Well, those are the mistakes that can kill an investment portfolio. And so, a lot of what's in new additions is the warnings about these kinds of things. And incidentally, this ARK Innovation Fund, which a year and a half ago sold at $150 is now selling at $30. So, avoiding mistakes is the second most important thing. And there's a lot of that material that I've covered.

Dr. Burton Malkiel:
The other thing is people have been fascinated with so-called ESG investing. Is there a way of doing good for humanity and doing well financially? That's what the advertisements say. Does it in fact work? So, what we've done in new additions is talk about what people are talking about in investing now and does it work or doesn't it work? Factor investing. A whole bunch of things that are very popular in the financial community, getting people up to date with what finance advisors are talking about and separating the wheat from the chaff, what you might listen to and what you shouldn't.

Dr. Jim Dahle:
Yeah, definitely things have certainly changed in the last 50 years, and I don't know if people would keep reading the 1st edition and get the important message out of it if it hadn't been updated and discuss some of those things.

Dr. Jim Dahle:
One of the concepts that I believe was in the 1st edition, I never read the first edition, but I believe it was in the 1st edition and has subsequently become very famous is the concept of the blindfolded chimpanzee. And most of us have heard this idea. The blindfolded chimpanzee throwing darts at a page of the Wall Street Journal can pick stocks better than an active fund manager. And interestingly enough, the Wall Street Journal actually ran a series for a while demonstrating that that was actually true. But most people may not realize that concept, I believe, came from the 1st edition of your book. Where did that idea come from, of the blindfolded chimpanzee?

Dr. Burton Malkiel:
Well, what you want to do as someone who writes about economics is so many people tell me that they studied economics for a while in college and found it so boring that they never continued with it. And so, one of the things I've always tried to do as a teacher is to try to make it as interesting as possible, using the right analogy, using the story that people can relate to that makes the point.

Dr. Burton Malkiel:
So, I had done this with the chimpanzee throwing darts at the Wall Street Journal. The Street Journal did run the contest. They let me throw out the first darts. Now, I wasn't really serious about the fact that you ought to select your portfolio by throwing darts. The right analogy is probably to throw a towel over the stock pages because I want you to buy and hold everything.

Dr. Burton Malkiel:
But the chimpanzee was something that people could relate to. It was interesting and that was in the first edition and it helped cement the point. So, really the thing I've tried to do in the book is always to make it interesting. There are little stories throughout that I hope people will find interesting. And if you thought that finance or economics was boring, I hope the people who look at the book will say it's actually fun to read.

Dr. Jim Dahle:
Let's talk for a minute about the efficient markets hypothesis. Why do people assume that because markets are not perfectly efficient, that we should not act as if they were?

Dr. Burton Malkiel:
Well, the analogy that I would use is the following. If you were talking about an engine, you're an engineer talking about an engine, would you ever say an engine was perfectly efficient? No. You'd say, relative to some ideal the engine is 90% efficient or 85% efficient. The market's not perfectly efficient. The market makes mistakes.

Dr. Burton Malkiel:
And sometimes it makes doozies of mistakes. For example, there are bubbles in the market. In January of 2000, all the high-tech stocks were selling for more than 100 times earnings. A normal earnings multiple is 15 or 17. And there was clearly a bubble. And some people would say, “Well, that proves to you that markets are inefficient, and you should never believe in the efficient market hypothesis as it was called.”

Dr. Burton Malkiel:
And I write about this. There's no question, the market went absolutely crazy. But here's the thing. The difficulty is there was no way to know in advance when the market had hit bubble levels and how much the bubble was going to inflate.

Dr. Burton Malkiel:
Now, people forget. It was Alan Greenspan, who at the time was the head of the Central Bank, the Federal Reserve, who coined the expression irrational exuberance. In talking about that, it was called the internet bubble, or the dot-com bubble. And stocks that added dot-com to their name would go up a lot because this was the way that you ought to invest. You don't want a broad-based index fund. You want to just be in the dot-com stocks.

Dr. Burton Malkiel:
Alan Greenspan was the one who coined that expression. But what people forget is that he coined that expression in 1996. And if you had simply bought a broad-based index fund in 1996, held it through the bubble and then held it later, you did extremely well making about 10% a year. And if in fact, you had instead bought these dot-com stocks, at the time, you would've been really killed financially.

Dr. Burton Malkiel:
The darling of the market at the time was a stock called Cisco Systems. Still exists. It makes the switches and it's called the backbone of the internet. Well, even today, Cisco Systems is selling for only about half of what it sold for in January of 2000. So, yes, there are bubbles, but trying to go and be smart, and I will then be able to avoid them, I'll just be out of the market at that time. It doesn't work because you got to know what you can know and what you can't know. There was no way that anybody could do this with any kind of accuracy.

Dr. Burton Malkiel:
And recently, I had mentioned GameStop. There was this bubble in so-called meme stocks where particularly with the internet, everyone thought that this was the way to get wealthy. And the stock doubled and then doubled again. So, you could think, “Well, look, smart people would know better, and they would be able to sell the stock short.” There was a hedge fund called Melvin Capital that sold GameStop short, and the hedge fund went bankrupt because they sold it short too soon.

Dr. Burton Malkiel:
So yes, these crazy things happen, but you're better off acting as if you'll never know when you have a bubble and when it's going to pop and how much it's going to inflate. You're still much better off assuming you can't do better than simply buying and holding a broad-based low-cost index fund.

Dr. Jim Dahle:
Now, we know how you feel about individual stocks. Do you think there is a place in an intelligent portfolio for digital assets of any kind, whether they're cryptocurrency or some other type of crypto asset, or an NFT? Is there a place for that in an intelligent portfolio?

Dr. Burton Malkiel:
Look, anybody who has studied the stock market for his entire life obviously has some bit of a gambling instinct. And I don't mind if you buy some individual stocks. If the core of your retirement portfolio is indexed, you want to take a flyer on an individual stock, I think that's absolutely fine. Go do it. So, do it only as an add-on to your retirement fund being in a good broad-based index fund.

Dr. Burton Malkiel:
Now, having said that, no, I would not buy any cryptocurrency. I wouldn't buy Bitcoin. I wouldn't buy Dogecoin. I wouldn't buy Ethereum. I wouldn't buy any of those. No, I would not buy an NFT. I would not bid on the people, the artist who sold for almost $100,000 his art NFT. I think this is all absolutely crazy.

Dr. Burton Malkiel:
So yes, buy individual assets in real companies. I don't think these digital assets are ever going to work. And let me just talk about that for a moment, because people think now that Bitcoin has gone down to $16,000, this is what you ought to buy, it's going to go back up. And it could, it could go back up. And is Bitcoin useful as a currency? Well, I don't think if I want to go to Starbucks and get my coffee that a currency that can be up or down 10% in a day is very useful. Would it be useful for something? Yes. I think if I wanted to do something illicit, if I wanted to buy some drugs, maybe I would love to have Bitcoin.

Dr. Burton Malkiel:
And that, of course, is the reason why it can never last for a long time. To the extent that it is useful, it's useful for doing sketchy things. It's useful for doing illegal things, and governments are undoubtedly in the future going to clamp down on it.

Dr. Burton Malkiel:
Now, I'm not a Luddite. The international payment system will improve over time. I wouldn't be a bit surprised if we have a digital dollar at some point. So, it's not that there won't be improvements, but Bitcoin itself, I think will never be it, nor will the other digital currencies. And I say avoid them and avoid all of these things that are going to be the wave of the future because those are often the things that will lead you to disaster as an investor.

Dr. Jim Dahle:
Turning the page to a different subject, I enjoyed the section of the book on new portfolio construction techniques. It talks about factor investing and risk parity, and ESG investing. And a lot of times when these new ideas come out every few years, there's good academic evidence for them. A lot of it is just backtesting, but there's good evidence. How can we determine when to listen to an academic on topics like these and when not to? How can we know if it really is different this time?

Dr. Burton Malkiel:
Well, it's a very good question. And one of the difficulties with a lot of the academic studies that I've pointed out in the book is these things work brilliantly in a backtest. But do they work in an X sample period i.e., do they work well, in a period after the backtest? And very often, they don't. And this is what I have tried to show.

Dr. Burton Malkiel:
Now, probably the most popular right now because there's a big company, BlackRock, that has been suggesting this, that you can do good and do well financially at the same time. And I'm particularly skeptical about this. And skeptical because I'm not even sure that the companies that are in these so-called ESG funds, are they really good?

Dr. Burton Malkiel:
There are rating agencies who rate companies as to whether they're good for humanity, whether they have good governance, and so forth. And they disagree completely. In fact, the correlation between the raters is as low as 0.4. And just to put that in perspective, the correlation between Moody’s and Standard & Poor's on bond ratings is 0.995.

Dr. Burton Malkiel:
So, there's almost no agreement, and there's a good reason why there's no agreement. Let's take a Midwest utility called Xcel Energy. And it gets a terrible ESG rating from some of the raters because they burn coal. But this is a utility that has promised by a date certain to be completely carbon-free. This is a utility that's doing more investing in wind and solar power than any other one. So, is it good because of its investments or bad because it's burning coal now?

Dr. Burton Malkiel:
Let's take another example. A natural gas company. Is natural gas a bad company because it's carbon, or is it a good company because in going toward a carbon-free world that we all would love to see, natural gas is the cleanest burning carbon and we're going to need natural gas over this period.

Dr. Burton Malkiel:
So, what worries me about ESG is when I look at the companies in an ESG portfolio, I wonder whether the companies that are in there are really as pure as they are supposed to be. Are they really good companies? Should I really feel good about owning Facebook or now it's called Meta, or Visa?

Dr. Burton Malkiel:
These are the companies that are often in these ESG portfolios because they don't do any polluting. But is our social media an unambiguously good thing for society? I'm not so sure. Visa that charges exorbitant rates like 20% to poor people who've gone over the limit in their credit cards, is this a good company?

Dr. Burton Malkiel:
When you start to think about it, and this is all I want people to do, is to think about people will advertise this is the best thing to do. And be very, very careful about it because, in fact, you don't outperform an index fund. In fact, you do worse than an index fund. So, you may neither do good for society or well financially.

Dr. Burton Malkiel:
Now look, a lot of people would like to feel good about their investments, and I said before, I don't mind you buying some individual stocks. So, buy an index fund for the core of your portfolio, and then you want to go and buy a company that makes wind tower fine. Good. Go do it. You want to buy a solar panel company, fine, go do it. But buy it as an add-on to your portfolio, not as your whole portfolio. Because if you do that, I'm convinced you will certainly not do well financially. And on some of these ESG funds, I'm not even sure that you're doing wonderful things for society either.

Dr. Jim Dahle:
The main ideas in your book, although they're controversial when they're first published, no longer really are. So, I'm going to turn to a few of your ideas that perhaps are a little more controversial and ask you to defend them.

Dr. Jim Dahle:
The first is using dividend-paying stocks as a bond substitute for part of a bond portfolio. The appeal is that stock dividend yields may be just as high as bond yields when interest rates are low, and you may get appreciation too. The downside is that you're still taking on equity risk with what is supposed to be the safe portion of your portfolio. What are your current thoughts on the topic?

Dr. Burton Malkiel:
And again, it's a very good question. How thoughts can change as markets change. We've had a remarkable change in our bond markets really over the last 18 months. When I had suggested bond substitutes, we basically had zero interest rates. And when you have zero interest rates, bonds are particularly risky as has been shown because bond portfolios have gone down during 2022, which was a terrible year for all financial assets. But the bonds didn't protect you.

Dr. Burton Malkiel:
I think that, in fact, dividend-paying stocks were at least as good, and probably even a little better. So, did I believe in it then? Absolutely. Do I believe in it as much today? And the answer is no. And I believe in it less today because today I can buy a one-year treasury bill at over 4%. I can buy a two-year treasury for over 4%.

Dr. Burton Malkiel:
So, what I would say today is that are a much better investment than they were. And the clear message about the stock alternatives was to do this during a period when interest rates were extraordinarily low. When interest rates have then risen as they have remarkably over the last year, then you don't have to do that. The advice was to do it only when interest rates were essentially zero.

Dr. Jim Dahle:
The second idea I want to push back a little bit on is the idea of overweighting emerging markets, frontier markets. China, in particular, you seem to have been a fan of the last few years. Do you think investors should overweight emerging markets in China in particular?

Dr. Burton Malkiel:
The idea was not really to necessarily overweight them, but for people who generally had zero in these emerging markets, they should make sure that they have some of their assets in them. And I definitely think they should continue to do that. Partly because of the demography.

Dr. Burton Malkiel:
We in the west are ageing rapidly. The work-age population is not increasing, and our growth rates are going to be a lot lower. The places in the world where the growth rates are high and where the workforce is increasing so that growth can continue are the emerging markets of the world.

Dr. Burton Malkiel:
The fastest growing economy in the world today is India. And India is the fastest growing economy in the world, in part, because the population is young and the population is growing quickly. Vietnam, Indonesia, these are the places where you have young populations and the populations are growing rapidly.

Dr. Burton Malkiel:
So yes, I think you ought to have some parts of your portfolio in these emerging markets. By overweighting, I don't really mean overweighting relative to… I don't want you to put your whole portfolio into these areas, but I certainly want you to have part of it.

Dr. Burton Malkiel:
Now, let's talk about China, though. China, I am somewhat less enthusiastic about than I was in earlier editions of the book. And I'm less enthusiastic because Xi Jinping, the leader of China, is much more like Mao the dictator than like Deng Xiaoping, who was the one who reintroduced capitalism into China and was responsible for the big growth rate.

Dr. Burton Malkiel:
I'm less enthusiastic about China because I am not particularly happy with the way government policy has changed. Would I avoid China completely? No, because it's very, very cheap. But clearly, I would have to agree with you that I am not going to beat the drums for China. And if you decided you didn't want to be in China because you really didn't like Xi Jinping, I would say fine. But don't avoid India. Don't avoid Indonesia because you're going to have much more growth there because the demography is so much better.

Dr. Jim Dahle:
As much as half of investment dollars are now in indexed investments, what percentage of the market do you think can be indexed before it becomes a problem?

Dr. Burton Malkiel:
I don't think we have enough indexing. Not that we have too much. If we had 95% of the market indexed, there would still be enough active people to make sure that information gets reflected in prices. And the paradox of the so-called efficient market hypothesis is you obviously do need some actively managed participants to make sure that when the drug company finds this new drug for cancer and is now worth double what it was before that the price adjusts.

Dr. Burton Malkiel:
Well, I think, if you had even 1% of the market, there'd be enough people like that. But just think also as a thought experiment, supposed we were 100% indexed and there is nobody who was going and doing that. The drug company has the cure for cancer. It's going to be worth double what it was, and it doesn't move.

Dr. Burton Malkiel:
In our free capitalist society, I can't believe that somebody isn't going to go, there's some hedge fund guy who's not going to go into the market and go and buy up that drug company and buy up that drug company until its price reflects the new information.

Dr. Burton Malkiel:
So, I'm not worried as some people are that we have too much indexing. I don't think we have enough. And I will never be worried that in our capitalist economy where there's freedom to enter the market, that there won't be somebody who comes in to make sure that information gets reasonably reflected in the price of stocks.

Dr. Jim Dahle:
Our time is now short, but this is going to be listened to eventually by 45,000 or 50,000 plus high earners, mostly doctors. What have we not yet talked about today that you think they should know?

Dr. Burton Malkiel:
Well, again, I think we touched on this, but I would say the lessons that I hope people take from this is that even if you agreed with my hypothesis about index funds, where the evidence I believe is overwhelming, that at least make sure that the core of your portfolio is indexed and look at the lessons that have been spelled out of the bubbles that we have and seem to consistently have and how easy it is to be swept up in these bubbles to read about them.

Dr. Burton Malkiel:
And be very, very careful because good investing is first of all to do the right thing, but perhaps even more important, to realize that we're like Pogo, we sometimes are our own worst enemy to avoid the really stupid things that we do that can ruin any investment plan.

Dr. Jim Dahle:
Awesome. It has been wonderful talking with you, Burt. It is great to have you on the podcast. Those who would like to read some more of Burt's writings, get to know him a little more, I recommend the 50th-anniversary edition of “A Random Walk Down Wall Street.” It just came out in January. It's completely updated. Talks about all kinds of new-fangled stuff, ESG investing, the meme stock mini bubble, cryptocurrency mini bubble, those sorts of things all in the book.

Dr. Jim Dahle:
It's a great personal finance book, but with a heavy focus on investing to reach your goals in an easy reproducible way, as he mentioned, by putting the bulk of your portfolio into broad-based low-cost index funds. Thank you so much for coming on the White Coat Investor podcast.

Dr. Burton Malkiel:
Thank you. I've really enjoyed it. I really appreciate it. Bye-bye.

Dr. Jim Dahle:
All right. That was great. Burton Malkiel, “A Random Walk Down Wall Street.” The man was born in 1932. He talks about not wanting to be poor at the beginning of the interview. 1932 everybody was poor. He was in high school going through World War II. He served in the army in the 50s. He's been a professor at Princeton since 1958. This is his 7th decade as an economic professor and still sharp as a tack. I hope my career goes that well, that I'm as excited about what I'm doing at 90 as I am now, and that my mind is as sharp as his is, still at that age. Pretty incredible really.

Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
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Dr. Jim Dahle:
For the rest of you, keep your head up, shoulders back. You've got this, and we can help. We'll see you next time on the White Coat Investor podcast.

Disclaimer:
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.