How to Invest Your Money

How to Invest Your Money Eric Schurenburg: Here at Moneywatch.com the investment monitors are buy index funds, diversity your assets and keep costs slow. Today we're joined by the economist who popularized those very ideas more than three decades ago Burton Malkiel. He's currently a professor at Princeton University and author of a new book, The Elements of Investing. Professor Malkiel thanks for joining us. Burton Malkiel: My pleasure. Eric Schurenburg: Now as I said we are big believers in the philosophy investing that you espouse but it hasn't been easy lately. People who did everything right, bought index funds, diversified their assets, still got hammered. Buying index funds meant you were down 25% even now from the peak. People like Jeremy Grantham are saying that proves that index funds don't work. It's more of a religion than an investing strategy. What do you think? Burton Malkiel: Well first of all the index funds during this last lost decade as it's often called, outperformed the typical actively managed fund. So you're right this has not been a great ten years for investing in the stock market but index funds consistently did better than about two-thirds of active managers. So index funds were not the problem. I also think that this last decade where the market ended up lower than it was at the beginning of the decade, actually proves some of these timeless lessons; namely, diversification. I've also said you ought to have some bonds as well as stocks. Bonds did very well in the last decade and a portfolio that was balanced between bonds and stocks did perfectly okay. You also want to be diversified internationally. You don't want to simply be in the United States; and in fact international stocks and in particular emerging market stocks did very well in the first ten years of the 2000's. So again, diversification helped you. Eric Schurenburg: So many people though have talked about all the different kinds of assets you'd need in a diversified portfolio. It seems to have gotten really complicated. You need to have commodities. You need to have real estate. What's your point of view about that? Burton Malkiel: Well, my since is and this is one of the reasons why Charlie Ellis and I wrote this book, The Elements of Investing. Both of us have written this kind of stuff before but what there hasn't been in the market is something that within 100 pages, we didn't quite make it because the typeface is big it's a little over 100 pages, but could you put all these lessons down in a very short book that you could access in an hour or two? And that's I think the difference between this book and other books and we also had a principle that we call the “kiss principle, keep it simple sweetheart”, that we don't think you need to be that complicated. We don't think you need to be in commodity funds; we don't think you need to be in hedge funds. We think that if you have index funds including index funds that cover countries like Brazil and like Australia that are very rich in natural resources, you get some of the benefits that you would have if you were in investing in commodities directly. So what we've tried to do is to suggest that with some very simple index funds and we list them, we tell the readers exactly where to go. International, domestic, emerging market, bonds; that you can get a lot of these benefits that some people think is much too complicated because you've got to get in to all these different asset classes. Eric Schurenburg: Okay so thoroughly diversified in stocks, bonds and cash is really all you need. Burton Malkiel: I think so. Eric Schurenburg: You've talked a lot about China and you surprised me by coming out in favor of China; I thought that violated some of your own principles like nobody knows more than the market. Everyone's been talking about China. What makes you think at this point that China would still be undervalued? Burton Malkiel: I didn't' say that China was undervalued and I'm not sure that China is undervalued. China, when you adjust it for purchasing power, probably is an economy that's about 13% of the world economy. I think it will be bigger than Japan in a year, I think in 20 years it will be bigger than the United States. And so what I'm saying is if you just indexed to the world economy, you will under weigh China and I don't want to under weigh China because it has been the most rapidly growing economy in the world over the last 20 years and I think it's going to continue to be the most rapidly growing major economy in the world. Eric Schurenburg: If there was one message that was the essential message of your book, what would it be? Burton Malkiel: You know I always like to say we should be very modest about what we know about markets. But the one thing I'm absolutely sure about is that the less money I pay to the purveyor of the investment product, the more there's going to be for me. And so low cost would be--you know if there's one lesson to come out of it, look for low cost solutions. I'm very fond of quoting my good friend Jack Bogle who says, "In the investment business you get what you don't pay for." Eric Schurenburg: Thanks Professor Malkiel let's leave it right there. Burton Malkiel: Thank you very much, enjoyed it. Eric Schurenburg: And thanks for watching.