Joseph William Burton

Transcription

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