John Rothmann – I’m John Rothmann, and as we’ve promised we have a very special guest joining us.  Mitch, tell us about this remarkable individual.

Mitch Tuchman – We’re so excited, we have Professor Burt Malkiel on with us, and Burt is a member of our Investment Committee at Rebalance. Burt wrote a book that I read when I was in college in the 70s, and I think millions of others have read the same book. It’s called A Random Walk Down Wall Street and it was published 40 years ago and it’s now in its eleventh edition. It is not 50 Shades of Grey, but it has sold 1.5 million copies and for finance that’s getting up there.

John Rothmann – Before we get going, Burt I have to ask you a question right out of the box – the most famous quote – a blindfolded chimpanzee can throw darts and do better than the pros. How in the world did you come up with that?

Professor Burton Malkiel – The fact is that what I have done from the very first edition of the book is to recommend so called “index funds”. Now an index fund is simply a fund that buys and holds all the stocks in the market, and the reason that that does so well is that there are a lot of smart people around who hear some information and that are buying and selling to make sure that any information that arises about a stock or the whole market gets reflected in its price.  Now that doesn’t mean the price is always right, in fact I like to say the price is always wrong, but the point is millions of Americans including very highly paid professionals are buying and selling and if they think the price is wrong they’re going to make transactions to change that price.  So the price really reflects everything that’s known about a stock. Therefore, if you just take the prices that are there and buy and hold, you’re going to do at least as well, if not better than all of the other people. In the other words, if the prices reflect the information a blindfolded monkey throwing darts can select a portfolio as well as the experts.

John Rothmann – But Burt I got a tip, I want you to know that, and you’re the first one to hear this – a company called Enron if I put all my money there I’m going to be able to retire with more than I could ever imagine. Not a good idea right?

Professor Burton Malkiel – No, not a great idea.  You happened to take a company that used to be a very admired company, but that was basically a fraud that was built on a number of lies and the price was actually wrong.  It does not mean that there aren’t some fraudulent people around or that there aren’t some Bernie Madoff’s around. You could do a lot worse than the blindfolded chimpanzee by simply following “tips”

Mitch Tuchman – So you have now published eleven editions of A Random Walk Down Wall Street and the original message was indexing, but there were other messages. Talk about some of the basic tenants that you put forth forty years ago and whether or not you still believe in them all still or if you have had any doubts about some of them.

Professor Burton Malkiel – I believe in indexing, the main tenant, even stronger than I did when I first wrote the book.  When I first wrote the book, index funds didn’t exist.  Three years later, Jack Bogle at Vanguard Group started the first index funds and index funds have proliferated.  There has been a lot of competition.  Their prices have been driven down so that you can then buy index funds close to zero cost.  More recently there are so called Exchange Traded Funds (ETFs), and these are index funds that trade very much like stocks, and again can be bought at expense ratios that are very close to zero.  So the fact is that from the first thought of doing this forty years ago to when they didn’t even exist, they now exist and they are almost costless and the data from the period from which you‘ve had index funds, the data is overwhelming that each year the index funds does better than 2/3 of so called “active” managers who try to pick the great stocks and the 1/3 that seem to win in any one year are not the same who do better in the next year. When you look over 20-30 years, its just overwhelming that 90-95% of active managers are beaten by the index.  What I like to say about markets is we all need to be cautious and modest about what we know and what we don’t know, but the one thing that I’m absolute sure about is that the lower the expense that I pay to the purveyor of the investment service, the better that I’m going to be and the more money there’s going to be for me.  So indexing remains one of the biggest lessons, but as you said Mitch, there are others and one of them, one of the great lessons, is the name of your company Rebalance.  I believe and have believed for years, and have the data to show that it works, the simple idea of rebalancing works wonders for a portfolio in that in that it always reduces the risk of the portfolio and in very volatile markets it will tend to increase your portfolio’s return

Mitch Tuchman – Rebalancing is a great concept that I learned early on from the book.  It’s a very hard to grasp concept to grasp sometimes because the financial world continues to tell the people that they are predicting this or predicting that and that forms the basis of making a change in the portfolio and what you recommended forty years ago and what we do is very different, isn’t it?

Professor Burton Malkiel – Look, nobody, and I mean nobody, can predict what the market is going to do, next week, next month, next year.  I started my career on Wall Street.  I have been in this business for more than forty years. I have never known anyone to be able to successfully predict the market over time.  You can get it right once in a while, but to do it consistently over time, I’ve never known anyone who could do it, and in fact I’ve never known anyone who knows anyone who could consistently predict the market.  What rebalancing tells you to do is this – if you’ve got a portfolio, which lets say, has some equities or some common stocks, and has some safe securities such as bonds and you want to have a balanced portfolio that’s let’s say 60% stocks, and 40% more fixed income, bonds, preferred stocks etc., that what you do is, you look at your portfolio periodically and you ask what’s happened?

Have you gone through a period such as the period during the internet bubble at the beginning of the 2000s where the stocks just went crazy up and the bonds were going down so instead of a 60:40 portfolio, you’re stocks were at 75% and your fixed income was 25%. What rebalancing tells you to do is take a little money off of the table, take the proportions down to that 60:40 that you’re comfortable with. You know it’s almost as if we’d all like a genie to tell us when the markets too high, when we should get out and nearest thing to it, is rebalancing.  Basically what this does is remove some of the risks of a portfolio, particularly when one asset class gets too popular and it will in volatile markets tend to increase your returns.

John Rothmann – Burt that’s my question for you, lets go back to 2008 when everything seemed to fall apart, if I had been involved in a rebalance would it have made a difference for me in terms of my investments?

Professor Burton Malkiel – Absolutely.  One of the mistakes that people made in 2008, and this is one of the other things that I pay a lot attention to particularly in more recent editions of the book, is so called “behavioral finance.” Sometimes in investing we are our own worst enemies and what we know that we do as individuals is we buy when everybody is optimistic, as people were in the beginning of 2000 and during a period like 2008 when the world seemed to be falling apart that’s when we tend to sell.  What rebalancing forces you to do, is to do just the opposite of what your instincts tell you because your instincts are always going to be wrong.  What rebalancing told you in 2008 was the stock market was low – instead of 60% in stocks, you may be only had 33-40% in stocks. Since the bond market was way up because the monetary authorities were reducing interest rates down to zero, bonds were way up. Instead, sell your bonds and buy more stocks so rebalancing protects you from these behavioral problems that you have, buying when you’re optimistic, selling when you’re pessimistic, and what it would have done in 2008 is got you more into the market at just the right time.

John Rothmann – Burt, I want to point out that you do serve on the Rebalance Investment Committee with Mitch and his partner Scott. We are going to take that break and when we come back, we are going to have a series of more questions for you. We will be right back, with the man who impresses me amazingly.