ETF Edge - Special Episode: Investing Legend Burton Malkiel

Episode Date: October 26, 2020

CNBC's Bob Pisani spoke with Burton Malkiel, professor emeritus of economics at Princeton University and author of “A Random Walk Down Wall Street,” and Dave Nadig, chief investment officer and director of research at ETF Trends. They discussed the evolution of retail trading, ESG, the market sell off and what investors should expect going into the end of the year. In the 'markets 102' portion of the podcast Bob will continue his exclusive interview with investing legend Burton Malkiel. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights in all things, exchange-traded funds, you're in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. And today on the show, we're talking to legendary investing icon Burton Malkiel about the state of the markets, the evolution of retail trading, ESG, and a lot more. He's one of the founding fathers of the efficient market hypothesis and one of the great thinkers who helped shape the success. of index investing today. Here's my conversation with Dave Naughtick, the CIO, and the Director of Research at ETF Trends and ETF Database, and Professor Burton Malcol, Professor Emeritus,

Adam Princeton University, and the author of the well-known historic book, A Random Walk Down Wall Street. Normally I'd start with the ETF question or something like that, but I got to start guys with the markets right now, down over 800 points in the Dow Jones Industrial Average and really been trending down for a while now. Professor, could you just give a us a minute of your thoughts on the markets right now. I know you've pioneered the random concept, but it certainly seems like the market is reacting to the news of stimulus or the lack thereof, and the fact that the reopening story for the moment is not going very well. No, exactly. I never said the market did not react to news. It does react to news,

but true news is something you can't predict from the past. And that's what we're One of the reasons why the market behaves somewhat randomly. What's happened is there was a much larger spike in coronavirus cases than we had anticipated. We had anticipated there would be some stimulus passed before the election. That does not seem to be the case right now. And so the market is selling off.

But look, what we do know is, that at some point the virus will be contained. At some point, we will have effective treatments. At some point, we will have an effective vaccine. At some point, we will get stimulus. Maybe not before the election. Maybe not even before the new administration comes in. But at some point, you know we will get the stimulus.

And so I say to investors, don't try to time the market. Certainly don't sell out now. in view of the market down over 800 points. Stay the course, and the best investors are ones that don't try to time the market. And Dave, you and I talk about this all the time. Certainly today, it doesn't seem to matter whether you're high beta guy, a low volatility guy, a momentum guy, a value guy, a small cap guy.

Pick your factor. It doesn't seem to matter that much today, Dave. Yeah, it's all going down. And, you know, I think that part of this is a bit of a recognition that the hope we had that the K-shaped recovery, for lack of a better term, was going to become a little more homogenous. I think that's going out the window. You know, we've got some big earnings coming out this week, folks like Caterpillar. I think that's getting a lot of people focused on industrials, which have had a great three-month run and are one of the things really taking it in the teeth today. I think people are just coming to grips with, as Professor Malkyel is saying, the virus is going to be here. stimulus isn't at least for some period of time. And that leaves us really on the back of what companies are actually able to do. It's hard to get behind industrial energy and those sectors that have really been hurt today. Yeah. Professor, I wonder if you can, for people who are still not quite aware of what your central contribution, I think, of the whole financial literature is, maybe you can reiterate for us briefly. Could you describe what a random walk is? And where did the

the phrase random walk come from? Is that a mathematical phrase or is it, does it describe something in particular? Random walk is a mathematical term. And what random walk really means is the market cannot be predicted in advance. I don't know what's going to happen. Is the market going to continue to go down tomorrow? Is it going to bounce back? I don't know and nobody else knows. So the best thing to do is stay the course and the best thing to do since we don't know whether growth is going to be better than value

or small is going to be better than large is to simply buy a broad-based, low-cost index fund. And ETFs are now available at essentially a zero-cost and stay the course. And that's going to be the way

to have the best long-term portfolio. And let me just say, the standard and pores, which is basically the company that measures how well index funds have done, they publish something called a SPIBA report, that is how the S&P indices compare with active managers. And what happens is, year after year, two-thirds of active managers are outperformed by an index. The ones that outperform one year aren't the same as the ones that outperform the next year so that when you compound this over 15 years, what the Spiever report show is that 90% of active

managers underperform. I'm not saying that nobody can outperform. Certainly there are people who do outperform, but it's a tiny, tiny fraction. And if you try to go active, you're much more likely to be able to be. under the curve than over the curve. And I believe even more strongly than I did 30, 40 years ago, that index investing ought to be the core of every single portfolio. And ETFs are a beautiful way to do it. You know, Dave, you and I know this. Of course, we talk about it all the time. But there is something, when I bring this up, that people, it guts under their skin. People don't like the idea.

that everything is just random. It just bothers them. The human brain seems to want to look for patterns because that helps us order the world that makes sense of the world, not that the world is a coin toss. Have you found a way to break through that sort of mental block that people have to describe

what Professor Malchia is talking about, this randomness? Yeah, I mean, fundamentally, this is the Lake Wobicon problem. Nobody wants to admit that they're going to be average, and Professor Malchola is, of course, absolutely right. right. If you want to have the highest opportunity for the maximum performance, the thing to do is buy a big broad index fund and forget about it for as long as possible. You know, I've recent study and Fidelity showed that the highest performing accounts they had were those that had either been abandoned or where the owner of it was dead. And I think that speaks volumes. That being said,

I do think the active funds we're seeing, certainly in the headlines today, are a little bit different than those average active funds in that the ones that are being successful are extraordinarily high conviction, meaning they're only holding 30, 40 stocks, they're holding fairly large positions. Again, you would expect mathematically, if you put all of those high conviction active managers together, they're going to underperform the market by roughly their fees and trading costs. But I don't think that's ever going to stop people from trying to, as you put, find those patterns and exploit them. Yeah. Professor, this random walk idea actually applies to other fields besides the stock market.

For example, I've heard you talk about basketball players before. I know you're a sports enthusiast that even in basketball, it's essentially a random walk. Can you describe that? And do basketball players believe it when you tell them? I'm sorry, but it's really just 50-50, whether you'll make that basket the next time or not. No, as Dave says, it's very, very hard to believe.

And the players themselves absolutely believe that there are patterns, that there's a hot hand. if you're a 50% free throw shooter and you've made three or four of your last free throws, basketball players will tell you it's much more likely than 50-50 that you're going to make the next one. And when you look at this mathematically, it just isn't true. It doesn't matter. It's like flipping a coin. If you've flipped three heads in a row, that doesn't mean that you're going to get ahead the next time. It's very hard for people to believe.

The basketball players themselves don't believe it, but it's unfortunately true, and you ought to act as if it is random and it is unpredictable. It's not that one free-frow shooter, who's a 70% shooter, isn't going to be better than a 20% shooter, but from one shot to the next, the fact that you've been good the last three or four shots, doesn't mean a thing. Right. But you just made a key point. You're not saying that talent doesn't matter. If a 70% free throw shooter is better than a 50% free throw shooter, but they fool themselves into thinking that there are patterns there that aren't, right? It's not that the talent doesn't matter. So if the stock market is a random, is a random walk, is it a perfect random walk? I don't want to

get too deep into efficient market hypothesis, but can you briefly describe that to us? and why that's very important to your basic idea here. It seems to me people don't understand it properly. So generally, efficient market hypothesis says that asset prices reflect all available information. Some people seem to think that that means that it actually says that the prices are accurate. But as you pointed out, that's not exactly what it says. Could you tell us very quickly what efficient market hypothesis is and what it is not at the same time? Sure. What it is is that news gets reflected very quickly and that prices move relatively randomly.

What it's not, absolutely not, is to say that it means that market prices are always right. In fact, I like to say they're always wrong. The problem is we don't know for sure whether they're too high or too low. Now, with respect to patterns, let me admit that there are some patterns. The market, if you had a mathematician on the program, the mathematician would tell you, yes, I've looked at the pattern of stock prices, and it's not a perfect random walk. It's close, but not a perfect one. Why is it not a perfect one? It's not a perfect one because there is some momentum. And there's no question about it.

It's one of the reasons why factor investors actually look for momentum patterns. But there are also momentum crashes. And the problem is momentum works sometimes, but sometimes it fails terribly. And you can't simply be a momentum investor through time and know that you're going to outperform because you won't over time, even if you will, during some periods. Right. Well, let me just follow up with that. And Dave, I want you to jump in after this, but I want to just follow up with that question. So if the market's not a perfect random walk, what patterns are there? I guess we're trying to figure out what advice can we give the average investor here. So there's been some academic evidence, I know, that some factors, value, for example, small caps, momentum, you mentioned, or quality generically seems to work for short periods. Is there evidence that this kind of factor-based investing really works? over long periods of time because the ETF community has certainly embraced those factor-based concepts, which I know are based on some, you know, earlier academic research done by FAMA,

yourself, and others that are out there. But what can we do with this information? Does factoring work? Factors absolutely can work. I think what people get into trouble is they think that there's some sort of magic bullet and that if I only get the timing right from going into lowball into momentum, I'm going to generate many percent alpha. That's not really what a multifactor portfolio does. A really modern, well-constructed multi-factor portfolio really just sort of changes your risk-reward paradigm fairly slightly. It gives you a little bit of extra or a little bit of risk reduction. And increasingly, the evidence suggests what it's really doing is helping you reduce risk more than anything else. And I think it gets to the previous point. It's not that all information

is in every stock price and therefore stocks are perfectly priced. We have constant new sources of information. A lot of work being done recently, for instance, on the importance of liquidity and how that can impact stock prices in unpredictable ways. So I think there's always new information being absorbed and the folks that are there absorbing it and processing it with a level head have an opportunity to generally reduce their risk a little bit. Yeah. Professor, why don't you follow up? Is there any evidence that factoring work or factors work? The ETF community has certainly embraced it, and perhaps about the multi-factor approach.

Dave mentioned that. Sure. If you're going to be a factor investor, I believe in a multi-factor approach. And the reason is that the factors tend to be negatively correlated. That is to say, when value fails, momentum tends to do well. And so I agree entirely with Dave that this is possible to have a multi-factor portfolio that tends to reduce risk and gives you a little higher sharp ratio. The sharp ratio is return relative to the risk you are taking.

So I agree with Dave that that is possible. Now, you want to do this, however, at low expense. If you've got a multifactor portfolio and you're charging 100 basis points, I say avoid that like the plague. But if you can get an ETF that's 10 basis points or less that does this, it's a reasonable way to invest. And there is some evidence that firms like dimensional fund advisors who have used a multi-factor approach for quite some time have in fact been able to bet, get a little better risk-return trade-off. So I'm not to be too plain spoken, but what's the poor slob who's trying to figure out what to do,

take away from this? Should I be going on buying a low-volatility ETF with a momentum ETF, with a value ETF and a small-cap ETF? I mean, it's a little confusing to give people actual advice. I know you're not a financial advisor, you're a professor, but that seems to be the implication of what you're saying. That's a multi-factor approach, buy all of that stuff? Well, I think it's much better to buy a multi-factor ETF

rather than have to buy the individual ones. A low-cost multi-factor ETF is a much better way to do it. And do I think it's not reasonable for someone to do that? I think that's absolutely right. I would, if I did anything beside a broad-based ETF that's indexed, I might do a multi-factor one, but again, I would not expect some great, greater performance.

You might get a little better risk reduction, but still, I think the safest thing to do would be buy a broad-based index fund. If you're interested in the factor approach, by one multifactor ETF with as low an expense ratio as possible. And by that, I mean something that's around 10 basis points or less. Because let me tell you, Bob, the one thing, I think we all need to be very modest about what we know

and don't know about the stock market. But the only thing that I am absolutely sure about is the lower the fee I pay to the purveyor of the investment product, the more there is going to be for me. And that I'm absolutely sure about. I love to quote my late friend Jack Bogle, who had this wonderful line that in investing,

you get, what you don't pay for. That's a great line. One of many Jack Bogle lines that I've used down throughout the years. The other one, my other favorite is the line, don't just do something. Stand there, meaning stand there, yeah. Use your brain in a crazy situation and make a poor investment or change where you're doing. Let me just ask you something about behavioral economics. in one of these questions. So people thinking that the market is efficient means that the market is rational,

but I think you've cleared that up. That doesn't really do that or say that. But one of the central findings of behavioral economics is that the irrational behavior is a big driver of markets. I've talked with Professor Schiller for many times about this. People don't buy low and sell high. They do the opposite, actually. So can poorly informed investors actually lead the market astray and make it less efficient? or is there some important philosophical or financial insight we can get from the lessons of behavioral economics? No, as I said, I think efficient market theory does not say the market's always right, it's always wrong. But what we do know is that people, when they try to time the market invariably, they sell at the wrong time and they buy at the wrong time. They buy when everybody's optimistic.

They sell when everybody is pessimistic, and that's just the opposite of what they should do. Don't try to do it. It's far better to simply buy and hold, and to the extent that you do any buying and selling, what I do recommend is rebalancing. That is to say, if you're in a situation where the market's gone crazy on the upside and your equity proportion is higher than you're comfortable with, then take a little money off the table and put it in safer assets. And when the market has, in fact, dropped precipitously and everybody is terrified about what will happen in the future, and your equity proportion has

gone down to lower than the proportion with which you should be and you're comfortable with for the long run, then go and sell some of the safer assets and buy the market. So I do agree with rebalancing, but I do not think that you should actively try to time the market. You know, Dave, you wrote a great story a number of years ago, which I still quote and go to call the folly of market timing, where you look at the simple observation that if you're in, if you're not in the market for like the 10 most important days of the year, you're basically lost. if you are in the market at the worst days of the year, you still lose. But your point of your story was nobody knows.

There are 10 days that are really important and nobody knows what the days are. Yeah, and I feel like that's true, not just in investing. I think it's true in life, right? And, you know, I think most of us get paid for 10 days at work a year, and we just don't know which 10 days those are going to be, so we have to get ready for the rest of them. But I think the point here is well taken. You know, your question, Bob, you know, what's an ETF investor to do?

Well, I mean, it's in the name of your show, ETF Edge. If you don't know what the edge is, then you don't have one, and therefore you should just be in low-cost indexes. It's not that there isn't information out there available that people can get an edge with. It's just infinitesimally small and very difficult to get. Yeah. Professor, I have to talk about ESG briefly. You wrote an op-ed in the Wall Street Journal. A few weeks ago, you said it was entitled, Sustainable Investing is a self-defeating strategy. I love that title.

where you went on to criticize ESG, saying, among other things, the scores are dramatically different depending on which ESD you look at, which is true. Could you tell us briefly, what is your concern about ESG? Well, my concern is that companies are very complicated, and it's impossible to say what's a good company and what isn't.

There are various services that give people, give companies ESG scores. And when you look at the point, pairs of these raters, they're correlated. The correlation is about 0.4. But they're also, that means that there's tremendous disagreement among the ESG raters. And just to put the 0.4 in perspective for bond ratings, the correlation between Moody's and Standard and Poor's in bond ratings is 0.99. That's where the rating really means something. Point four means that some raters would think that some company is great. Another raider will think some company is poor.

The utility that burns coal now, that one raider thinks is absolutely to be totally avoided, but that utility is making huge investments in wind power. And another raider says, these guys, are really good and they've promised to be carbon-free in a couple of decades. Who's right? We don't know who's right. And then when you look at the ETF portfolios that are broad-based ESG portfolios, look at the top 10 stocks. And are you really going to feel good about owning them? What are they? Well, Facebook is typically in the top 10. Visa and MasterCard are in the top 10. So should I be happy owning Facebook where there are problems of personal privacy,

where there is problems of misinformation and disinformation? Should I be happy owning Visa and MasterCard that charge interest rates to poor people of 20% or more? I don't know. I don't look at those ETF portfolios and feel terribly good about it. If you want to be an ESG investor, I say have the core of your portfolio a broad-based index fund. And then if you want to go and invest in renewable energy, then either buy companies or an ETF that's a pure renewable energy company. But don't buy a broad-based ETF that is supposedly a great moral way to do good things for everybody and make money because you're fooling yourself if either that the companies are all good, and you're fooling yourself if you think you're going to make more money that way. You're a big proponent of that, what I call the 10% rule.

You've said this before with other things. So people have a sudden itch to think that they're great stock pickers all of a sudden. Fine. Take 10% of your income and go and play around with it, but keep the rest in the low-cost index funds. It's almost like a 10% rule you're espousing. You said almost the same thing with ESG. If you feel strongly about renewable investing, then take a little bit of your money and do it, but keep most of it in index funds. Is that a fair, you know, characterization of the way you feel about it?

I'm not saying that you shouldn't stray and buy other things. You can do so with much less risk if the core of your portfolio, your serious money is indexed. I naturally, this will surprise you, but even Jim Kramer has come to, the realization he used to say that index funds were terrible. Now he says, put your serious money into an index fund and then take your mad money, which is the name of his show, and you can put it in individual stocks. You can put it into factor ETFs. You can put it into an an ETF that has a particular mandate. And I myself, I've got my serious retirement money entirely indexed, and then I'll buy individual stocks and I'll buy individual ETSs because I can do so

with much less risk because the core of my portfolio is indexed. Dave, just to end this EFG conversation, how should we look at ESGs? Is it kind of a factor investing? Is it a separate asset class? I mean, what do you advise people who want to have a diversified portfolio? I'm trying to figure out what's the right way to look at ESG? What is it? Well, one thing that Professor Malcol is absolutely right on is that no two people really can even agree on what we mean when we're talking about ESG. For one person, it's about climate change for another person, it's about regulatory compliance. And I think the reality is you have to go into an ESG investment with your own definition. What is, what is

is important to you, and certain components of ESG, particularly things around governance, for instance, have actually proven to be excellent risk management metrics, and their whole portfolios that are really focused on that G and ESG that have done quite well. And McKenzie just published a study saying roughly 63 percent of the studies done on ESG portfolios suggest there's net positive impact on performance. So I don't think it's true. You have to think about this as a thing you're giving up. I think ESG considerations are becoming part of how major institutions allocate trillions of dollars, and therefore to ignore it entirely is to potentially put yourself in front of a steamroller. So whether you believe in ESG or not, it exists, and a ton of money

is chasing it, and therefore it's going to impact securities prices. So you've got to be paying attention. Thank you, Dave. Very good summation, as you always do. We're going to continue this conversation with Professor Malco, a little bit on the history of the random walk. You might be wondering, why are we spending all this time talking about random walks and efficient market hypothesis and what the heck are these people talking about? This is the foundation upon which the concept of index investing is based upon. It's the theoretical foundation. It's the academic foundation for the whole thing. So if you're going to do this kind of investing and you're thinking, well, why am I buying an index? There's a reason why. And Professor Malchel,

Eugene Fama and others have historically been very involved in this discussion, and a random walk has now in its 12th edition. And it's a very important book. It had a big impact on me when I read it 25 years ago. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is our Markets 102 portion of the podcast. Today we'll be continuing the conversation with Wall Street legend, Burton Malkio. You like being called a Wall Street Legend? Does that fit well with you? You're proud of that designation. You certainly deserved it. Well, I actually find it very amusing. One of the things before the pandemic were in Europe, I was giving some lectures in Europe, and I was introduced as a guru, which made my wife really

smile and laugh. So I find it amusing. and maybe it's a good thing, but I really don't consider myself legendary or really very very guru-like, but hopefully I have done some things that will make a number of people better investors and make them have more secure retirements. That's what I'm proud of. You certainly impacted me. Yeah, well, you should be. You certainly impacted me.

When I became the Stocks reporter, I was the real estate reporter from 90 to 96, I became the Stocks Reporter here in 97. And in preparation for that, I read a bunch of books, but I remember reading a random walk down Wall Street. And then the book was more than 20 years old. I don't know what edition I found, but I found that. And along with meeting Jack Bogle, it made a tremendous impact. on me. So I can't imagine in 1973 what it must have been like to advocate index funds.

First off, there wasn't any index funds, right? Right? I mean, it'd be nice to have an index fund, something to invest in it. They didn't even have it. I can imagine Wall Street must have pillory you. I mean, they still do pillory you for the idea of like, oh my God, it's socialism to invest in index funds. So you must have had a real uphill fight at that point. reviewed in Business Week by a Wall Street professional who said that this book was the greatest piece of garbage he had ever read.

So you're absolutely right. And it wasn't until three years later that index funds started, that was started by Jack Bogle in 1976, three years later. And interestingly enough, as an investment product, it was a total failure. The first index fund was done as an underwritten offering.

They had hoped to raise $250 million. They raised $11 million. And it never really made much headway after that. The index fund was then called Bowdo's Folly. and I used to joke with Jack because when I left Washington, I was on the Council of Economic Advisors in 76. I became a director of Vanguard, and I would joke with Jack Bogle that he and I were the only investors in what was called the first index fund. So no question about it. It was thought of as being not only heresy, but absolutely ridiculous, and people didn't like my book.

And they certainly didn't like Jack Bogle, who actually bet his company on having the first index fund. Well, that's a very good observation, because I know you were on the Vanguard board for, what, 28 years, right? Something like that? Almost three decades. That is correct. You joined in, what, 1976 or 77, right, the board? So you and Jack were very, very close. We were.

Is it fair to say Jack essentially founded Vanguard on that basic idea, on the indexing ID? He bet the company on that. Am I exaggerating? Is it not quite accurate to say it that way? It seems that way to me. At all. Vanguard was a very small company. And it was basically all actively managed funds.

And when I joined the board, there was less than $2 billion under management. And I remember at my first board meeting, one of the directors said, we're hemorrhaging. We're losing funds all the time. And what Jack recognized is one had to do something different. And so he made it no load. He started index funds. He started the first money market funds. He started municipal bond tax-exempt money market funds.

And now Vanguard is a $5,6 trillion enterprise. and is one of the leaders leading money management firms in the world. Yeah. I don't think people know about your connection to the ETF business, because in addition to helping out the index business from the very beginning, you were present at the creation. As I recall, you were a governor at the American Stock Exchange when the first ETF came to market. That was the SPY, that was in the early 90s.

Am I right on that? You are absolutely correct. I was a governor of the American Stock Exchange and I was chairman of the New Products Committee. And we had this idea that we ought to have an exchange traded fund. We actually, Nate Most, as a name that maybe most people will not remember, but Nate was the executive at the American Stock Exchange who worked with me on this. We tried to get Vanguard to be interested in it because the only disagreement that Jack Bogle and I ever had was I was always a fan of ETFs and he didn't like them. So Standard & Poor's finally did it. The SPY was the first one.

It came to market listed on the American Stock Exchange, and the rest, as you know, is history. Yeah. You had a disagreement with Bogle over ETS, and I'm on your side on this. You know, Jack always felt for some reason that ETFs would somehow encourage day trading in some way. I was always mystified by that. his successor, Brennan, essentially overruled him, and Vanguard is now a monster in the ETF business. So your position was right, and I spoke with Jack about this many times. He never seemed to get over the idea, oh, it's going to encourage too much day trading. Was that as,

did you ever have any success in moving the needle with that with him? Not, not a bit. It's the one thing, and I, look, I was a wonderful, Jack was a wonderful friend. And I, agree with 90% of the things that Jack said, but this was one where we could never agree. Jack would say, why would anybody want to buy the market at 10 o'clock in the morning and then sell it at 1.30 in the afternoon? They're going to cut their throats if they try to do that. And I would say, Jack, you don't think that's a smart thing to do, and I don't think that's a smart thing to do. But there are going to be people who want to do it and try to do it. If they do it within the context of a mutual fund, they'll create costs and possibly tax consequences for other investors.

If they do it in the ETF format, it's the brokers who go and do the buying and selling. They're not creating costs, and they're not creating tax costs for other investors. and therefore the ETF is even a better instrument for the long-term investors. But I was never able to convince him. Good point. Let me just hit you on a few very quick comments on. You had some famously nasty comments about technical analysis. Give us one minute on what you think about technical analysis in general,

because we talk about it all the time on CNBC, but you've had some very pointed observations about it over the years. Look, one of the problems is that when you actually do careful statistical analysis of, let's say, give me any technical indicator, should you buy after double bottoms, should you sell after double tops, the answer is when you look at the statistics, it just doesn't make any sense. The one thing I would say about technical analysis is there is some momentum in the stock market. There's no question about that. Statistically, you can find that there is some momentum, and that's why this is one of the factors that is typically used in factor-based portfolios. But what we also know is it doesn't work all the time.

There are momentum crashes. and if you try to be a momentum investor all the time, it's not going to work. So, yep, the market's not perfectly random, but it's very, very close to being that. And don't try to think that you can play the momentum game and you'll outperform it. And what about fundamental analysis? Of course, that's the other side. Fundamental people seem to think that there's some scientific basis in looking at earnings, cash flow, internal documents. What, if any, is the fundamental problem with fundamental analysis?

Well, the fundamental problem is the following. If you try to do that and you've done that over the last two or three years, what you would find is that value stocks are now cheaper relative to the market than they have ever been before. Well, maybe not ever been before because we did have the boom in 1999 and January of 2000, where the growth stocks were even more highly valued than they are today. But just in general, if you've been a value investor, which is what fundamental analysts love to look at, you sure didn't do very well over the last two or three years. So even there, it's not going to work. It's not a surefire way to outperform.

At some point, value stocks are going to do fine, I'm sure. But I don't know when it will be and you don't know when it will be. And it's far better to just hold a diversified, broad-based index fund. Two or three quick questions. I just want to get your investment ideas for the viewers here. What should a well-rounded portfolio look like? I know you've been in favor of broad diversification. Does that include foreign markets, a mix of international U.S. stocks?

What are you recommending to people? The broadest base of stocks that you can find, and that does mean international. That means Europe. That means Japan. And it definitely means emerging markets. Because one of the things we know is that emerging markets are growing faster, than developed markets. Emerging markets have populations that are growing, unlike developed markets where populations

are not growing rapidly. And in places like Japan, the population is actually declining. And in emerging markets, the populations are younger. So they will continue to grow faster. And their valuations today are far more conducive. to good returns than valuations in the U.S. market. So very, very broad diversification, and don't neglect emerging markets. Yeah.

What about bonds? I mean, Bogle, I remember, popularized the idea that bonds should equal your age. So 60, 40, if you're 60 years old, you have 60% in bonds. That doesn't seem to be very workable anymore. I mean, what can you do? Should you own any bonds at all? Should you have bond substitutes? Just briefly.

How should you approach bonds? Bob, one of the things that's changed in Random Walk, and it's gone through 12 editions now, the general thesis, you're better off with index funds, hasn't changed one iota. But what has changed is, I have become increasingly negative on bonds. It was one thing to love bonds

in the 1980s when you could get double-digit yields on U.S. government securities. Today, we're in an age of financial repression where governments not only in the United States, but in Europe as well, have driven interest rates down so that their yields are nowhere near giving you a good rate of return and compensating for inflation. The 10-year Treasury today with yields of under 1% and an inflation rate close to 2% have negative real rates of interest. In Europe and Japan, there are negative nominal rates of interest. Well over half of the bonds traded in Europe and Japan

have negative nominal interest rates. So I don't think that a bond portfolio makes sense. I think you want to be very, very careful about bonds to the extent that you want some absolutely safe assets buy something that is essentially a cash asset, a Treasury bill, where you'll get a return of your money, not a return on your money. Look for bond substitutes where there are a lot of very good quality stocks that have good dividends and relatively safe dividends.

But I do not think that a general bond portfolio, even for investors who are retired and want a lot of safety, makes any sense in today's environment. Okay, Professor, I'm going to have to leave it there. This has been wonderful and just so informative for our viewers. Thank you very much. And folks, we have been talking to Burton Malkiel, the Professor Emeritus of Economics at Princeton University and the author of A Random Walk Down Wall Street. Professor, thanks very much for joining us.

Thank you, Buzz. That's it for today. I'm Bob Bizani. Thank you for listening. And make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge. NBCNBC.