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A Random Walk Down Wall Street is an investment book classic that was first published back in 1973. The ninth edition I borrowed at the library was published in 2007.

Burton Malkiel started his career doing research for brokerage firms. Today he is a professor in economics at Princeton University. He is a former member of the President’s Council of Economic Advisors and has served on the boards of major corporations, including the Vanguard Group of Investment Companies and Prudential Financial Corporation.

In this book, Dr. Malkiel shares the distilled wisdom of academic research into investment results from different investment styles.

Many of us have heard of "competitions" where chimpanzees throwing darts at lists of stocks defeat Wall Street professional analysts. In A Random Walk, Malkiel explains some of the "why" and "how" of what happens on Wall Street, and gives some suggested asset allocations for different stages of life.

According to Dr. Malkiel, the two most popular approaches are the "castle in the air" theory, also known as technical analysis, and the "firm foundation" theory, also known as fundamental analysis.

The "castle in the air" theory says the intrinsic value of a stock isn’t important. What is important is current trends. As long as you "buy low" and can find a bigger fool so you can "sell high" at the right time, you can make a lot of money. Technical analysts make stock charts to try to discover these trends. When many investors follow this "castle in the air" approach, we experience a "bubble" of inflated value, followed by a crash. A classic example was the internet boom of the late 1990s, followed by the crash in 2000 and 2001.

A real issue for the "castle in the air" approach is getting caught up in the exuberance of the marketplace late in the game and not selling at the peak of the market. In other words, you are likely to "buy high" and "sell low." Short term investing is a gamble.

The "firm foundation" theory is to find companies that have great potential to grow or generate income. Fundamental analysts research candidate companies to determine if they are desirable investments.

The issue of the "firm foundation" approach is the market tends to be efficient. Information is quickly disseminated and the price of the stock is adjusted to deliver an appropriate market rate of return.

Similarly, if any trading advantage is discovered, like an advantage buying on Monday and selling on Tuesday (I made it up!), the market will quickly adjust to eliminate the advantage.

Although the "castle in the air" and "firm foundation" approaches may be more fun, those who get more consistent results follow the "random walk" approach of choosing a diversified portfolio and holding it, with occasional rebalancing, for the long term.

As the investor gets older, the time horizon becomes shorter. You may no longer be able to recover from market losses. In that case, the portfolio should include larger allocations of short-term bonds, which will result in lower returns.

Malkiel recommends using "passive investment" funds, such as Vanguard’s index funds. Since these funds don’t change their holdings very much, they have low transaction costs. Also, since no research is involved in selecting the investments, they have very low management fees. These are two significant advantages over conventional mutual funds and managed accounts.

A Random Walk Down Wall Street has been tested over time as a sound, long-term investment approach. Since we are all concerned with planning for our long-term financial welfare, this book should be required reading for everyone.

Buy it on Amazon: A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition).

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