Market Beat: Is the random walk a good investment tool?
TRUCKEE, Calif. andamp;#8212; The random walk is a term that applies to investing. Itandamp;#8217;s kind of like taking your dog along with you on a hike. You both walk the Pacific Crest Trail from Donner Summit to Castle Peak. You start at the same time, make it to the peak and back to the car at the same time, but along the way, while you follow the trail, your dog crisscrosses it constantly.The random walk theory is widely accepted and has many applications in science. Burton G. Malkiel, a professor of economics at Princeton,, wrote a book called, andamp;#8220;A Random Walk down Wall Street,andamp;#8221; in which he presented the theory that stocks follow a random path and that future prices cannot be predicted. He argues that since itandamp;#8217;s impossible to predict the future price of a stock, or the stock market in general, that the best strategy is to buy and hold low cost index funds. While that practice may work very well when stock prices are trending higher in a bull market, it may not work so well during times of economic uncertainty and high volatility.According to information on the Standard and Poorandamp;#8217;s website, the total return for the Sandamp;P 500 for the last three years ending on May 31 has been 14.92 percent, which isnandamp;#8217;t too bad. But if you had invested five years ago on May 31, 2007, youandamp;#8217;re total return including dividends would be negative; minus -0.92 percent. Five years and your investment has lost money.Going back even further, all the way to 1999, the Sandamp;P 500 was higher on June 1, 1999, than it was on June 1, 2012 andamp;#8212; thatandamp;#8217;s 13 years and the price is lower and thatandamp;#8217;s in dollar terms. Your purchasing power over that time has been declining at the rate of inflation. Inflation over that time frame has been about 2.5 percent per year. That means that you have to earn at least 2.5 percent per year just to maintain your purchasing power.Even though there is evidence that stocks do follow a random pattern, the simple strategy of buying and holding low cost index funds has not worked well for many investors even over relatively long time frames. Investors today are challenged by both mediocre index performance and record low interest rates and may need to consider other strategies.Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at http://www.fusiontargetretirement.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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