Burton Malkiel

“The amount of risk you can tolerate is partly determined by your sleeping point. The next chapter discusses the risks and rewards of stock and bond investing and will help you determine the kinds of returns you should expect from different financial instruments. But the risk you can assume is also significantly influenced by your age and by the sources and dependability of your noninvestment income.”

“Determining clear goals is a part of the investment process that too many people skip, with disastrous results. You must decide at the outset what degree of risk you are willing to assume and what kinds of investments are most suitable to your tax bracket. The securities markets are like a large restaurant with a variety of menu choices suitable for different tastes and needs. Just as there is no one food that is best for everyone, so there is no one investment that is best for all investors.”

“Most people need insurance. Those with family obligations are downright negligent if they don’t purchase insurance. We risk death every time we get into our automobile or cross a busy street. A hurricane or fire could destroy our home and possessions. People need to protect themselves against the unpredictable.”

“Remember Murphy’s Law: What can go wrong will go wrong. And don’t forget O’Toole’s commentary: Murphy was an optimist. Bad things do happen to good people. Life is a risky proposition, and unexpected financial needs occur in everyone’s lifetime. The boiler tends to blow up just at the time that your family incurs whopping medical expenses. A job layoff happens just after your son has totaled the family car. That’s why every family needs a cash reserve as well as adequate insurance to cope with the catastrophes of life.”

“The paradoxical result of this analysis is that overall portfolio risk is reduced by the addition of a small amount of riskier foreign securities. Good returns from Japanese automakers balanced out poor returns from domestic ones when the Japanese share of the U.S. market increased. On the other hand, good returns from U.S. manufacturers offset poor returns from foreign manufacturers when the dollar became more competitive and Japan and Europe remained in a recession as the U.S. economy boomed. It is precisely these offsetting movements that reduced the overall volatility of the portfolio.”

“Portfolio theory begins with the premise that all investors are like my wife—they are risk-averse. They want high returns and guaranteed outcomes. The theory tells investors how to combine stocks in their portfolios to give them the least risk possible, consistent with the return they seek. It also gives a rigorous mathematical justification for the time-honored investment maxim that diversification is a sensible strategy for individuals who like to reduce their risks.”

“There are, I believe, five factors that help explain why security analysts have such difficulty in predicting the future. These are (1) the influence of random events, (2) the production of dubious reported earnings through “creative” accounting procedures, (3) errors made by the analysts themselves, (4) the loss of the best analysts to the sales desk or to portfolio management, and (5) the conflicts of interest facing securities analysts at firms with large investment banking operations. Each factor deserves some discussion.”

“Technology will ultimately greatly improve the intentional payments system. And there will always be advantages to holding an asset that is anonymous and transportable without a physical trace. But the lessons of history are immutable. Speculative bubbles will persist. But they ultimately lead most of their participants to financial ruin. Even real technology revolutions do not guarantee benefits for investors.”

“Our survey of historical bubbles makes clear that the bursting of bubbles has invariably been followed by severe disruptions in real economic activity. The fallout from asset-price bubbles has not been confined to speculators. Bubbles are particularly dangerous when they are associated with a credit boom and widespread increases in leverage both for consumers and for financial institutions.”

“Part of the genius of financial markets is that when there is a real demand for a method to enhance speculative opportunities, the market will surely provide it. The instruments that enabled tulip speculators to get the most action for their money were “call options” similar to those popular today in the stock market.”

“The firm-foundation theory argues that each investment instrument, be it a common stock or a piece of real estate, has a firm anchor of something called intrinsic value, which can be determined by careful analysis of present conditions and future prospects. When market prices fall below (rise above) this firm foundation of intrinsic value, a buying (selling) opportunity arises, because this fluctuation will eventually be corrected—or so the theory goes. Investing then becomes a dull but straightforward matter of comparing something’s actual price with its firm foundation of value.”