Talking the Walk With Burton Malkiel

Do you think the bubble psychology has been finally beaten out of investors, or is it still with us?

Professor Malkiel: I think investors have been burned by the Internet bubble and are more aware of speculative excesses now. However, while I would like to think that investors will apply what they learned from the past few years to investing in the future, speculative crazes seem to be isolated from the lessons of history.

Why is indexing, in your opinion, the most sensible way to invest in the markets?

Professor Malkiel: In the 30 years since the first edition of the book was published, index fund investing has proved the most successful investing strategy. The passively managed S&P 500 has regularly topped the performance of more than two-thirds of the mutual funds actively managed by professionals.

How do you account for the active fund managers who have managed to beat the market? A recent Ibbotson study found that winning U.S. stock funds, over the long haul, do repeat good performance.

If you have a room full of people in a coin-flipping contest to see who can flip heads the most times, one of them will invariably flip heads nine times out of 10. But that doesn't mean that person will flip heads more than even half the time during the next 10 flips.

Mutual fund managers who have beaten the market over a certain period have typically underperformed the market subsequently. I have demonstrated this in earlier editions of the book, and the latest figures prove that it remained the case during the 1990s and this decade. As I point out, the top-performing mutual funds of the 1970s underperformed during the 1980s. The top-performing mutual funds of the 1980s underpeformed during the 1990s.

This is even more dramatic when you look at the "hot" funds of the late 1990s. Fund managers who did exceptionally well in 1998 and 1999 managed to outpace the S&P 500 by over two times. In the early 2000s, they have underperformed the market by about three times.

Does this mean there are no individuals who can consistently beat the market? No. But, unfortunately, one only recognizes genius in hindsight. Warren Buffett is indeed an investing genius. But trying to find the next Buffett is like trying to find a needle in a haystack. Why not just buy the haystack?