Burton Malkiel

IFA's Quote of the Week - 10 (Burton Malkiel)

Burton Malkiel

Step 9 - History"Historically, the stock market is like a gambling casino with the odds in your favor. Over the long pull, stocks are given something like nine and a half to ten percent compounded per year. The banks have probably given you something in the order of four to five."


Burton Malkiel, 20/20 Interview with John Stossel,
November 27, 1992



Over the last couple of months, rumors of inflation and recession have been bandied about among the news media with increasing frequency. Concerns over the US economy and the issues surrounding the housing crisis have incited fear that the economy may erupt into a situation not seen since the Carter Administration when recession and inflation dealt a double whammy to the stock market and gold soared to new heights.

IFA does not make predictions about future economic conditions. We take this position for one simple reason: all of the information that is knowable about the market and the economy is reflected in stock prices as they scroll across the screen.

As to recession: are we in one?  We won’t know until we are at least two quarters into one because a recession is two back-to-back quarters of negative GNP.  However, if we are in a recession, the best strategy still remains to hold. No one can predict future news.

Take a look at the total return of IFA’s Index Portfolio 70 during and one year after six recessions.

Recessions are a normal part of the business cycle and occur, on average, every six years. Furthermore, stock market history shows that recessions have provided good investment opportunities.

As to inflation: Inflation is an equal opportunity destroyer of an investment’s purchasing power. There is nothing you can do about its effects, but investing as large a portion of your portfolio in stocks for as long as possible is the best way to outpace inflation.

Burton Malkiel’s quote above explains why you should invest in the equity markets to the greatest extent your risk capacity allows. Rightfully so, you can expect that over time, equity investment returns will exceed the risk-free rate, a rate which essentially pays little more than the rate of inflation. You are entitled to receive a higher return when you take more risk. Of course, the more risk you take, the more volatility you should expect. This is your reward for hanging on through periods of volatility. 

Investors should take on as much risk as their risk capacity allows to mitigate against the erosive effects of inflation. The figure below reveals the benefits of investing in Index Portfolios (IP) as opposed to various asset classes, including gold, silver, art, farmland and venture capital. As the chart shows, for the 48-year time period shown, globally diversified Index Portfolios. IP5, IP50 and IP100 maximized returns at their level of risk. Meanwhile, art, gold and silver carried unrewarded risk. Venture Capital carried more than twice the risk of IP100, with only small increase in return that did not justify the increased risk. It is important to note that this 48-year time period includes the 1973-1974 downturn which was painful in the short-term for stock market investors, but worked out very nicely for those who bought and held a risk-appropriate Index Portfolio.

Let's look at the substantial underpinnings of a globally diversified Index Portfolio. Specifically, what is in an Index Portfolio, and why do we carry such confidence in the success of an Index Portfolio in the long-term? In the most basic of terms, an Index Portfolio is an investment in global capitalism. In fact, the hypothetical stock certificate below represents Capitalism, Inc., IFA’s favorite stock and the only one we recommend. It shows the estimated 2006 market value, sales, net profits, great minds and hard-working employees that work for you when you buy and hold a globally diversified Index Portfolio. It shows $29 trillion in market value for more than 16,000 companies. The certificate reflects employment for more than 60 million people in 192 countries. Based on data regarding an-all equity Index Portfolio 90, Capitalism, Inc. has net profits of $3.5 million every minute, $5 billion every day and nearly $2 trillion for 2006. (Click on certificate to view disclosures.)

The individuals who collectively work toward the sustainability of capitalism apply world-class resources, brain power, technology, ingenuity and good old-fashioned hard work and perspiration to not just survive, but to thrive. Can anyone reasonably believe that Capitalism, Inc. will go out of business? And, if it did, your money would be worthless anyway.

We don’t know the news that will move the market – and neither does anyone else. If the news that hits the market is perceived as more bad than good, the market will go down. If the news is perceived as more good than bad, the market will rise. But, remember this important caveat: the news keeps on coming – all day, everyday. For this reason, it’s important for you to fully understand the history of the markets and how much risk you can take, and invest in a globally diversified portfolio that packs as much of the right risks as your risk capacity allows. Cost control, risk management and style drift avoidance are accomplished by constructing the portfolio with passively managed index funds.

Invest in Capitalism - It Works.