Editor’s note: This article was first published in September 2016; the new editions of the books it recommends are those available in 2015–2016, and its IBEX 35 example is from summer 2012.
The most profitable investment strategy, without a doubt, is to take a market that has fallen (like the IBEX 35 in the summer of 2012), pick a few solid companies that have been hit hard, and hold them for the long term, collecting the dividends on top of the rise in the share price.
On the other hand, it also pays to be a visionary and spot the next Google or the next Apple while those companies are trading at very low prices. For some reason, both strategies are very hard to carry out. If it were easy, we would all make a fortune on the stock market.
Let’s suppose you want a crash course in stock market investing or in understanding the markets.
What are the two best books for understanding stock market investing?
We’re not going to belittle what I personally call the bible of investing, Benjamin Graham‘s famous book The Intelligent Investor, which explains an investment method that can’t go wrong: value investing.
This time, though, we’re going to name two books that, in a way, are at odds with each other: A Random Walk Down Wall Street, by Burton Malkiel, and Irrational Exuberance, by Nobel Prize winner Robert Shiller.
Both books are classics that keep coming out in new editions. A Random Walk argues that the market is so good at setting the fair price of a share that there’s little point in stopping to try to guess something the market itself is already reflecting.
Irrational Exuberance, by contrast, says that share prices are sometimes incredibly high or low, and in either case it would be madness not to notice a bargain or a bubble. Both books contain plenty of useful examples that explain their authors’ theories.
Either way, an investor has to learn to live with the uncertainty of owning shares in a market that may or may not be rational, so it’s a matter of taking the ideas from each author. We’ll say up front that, although their underlying messages may contradict each other, neither author is wrong in his view of stock market investing.
See also: 8 financial education and personal finance books you should read
Burton Malkiel will guide you through building a balanced, diversified investment portfolio, often naming low-cost index funds, though he also explains some far-reaching ideas.
Robert Shiller, on the other hand, devotes a chapter to dismantling the orthodox versions of the efficient market and “random walks”, which, put another way, strikes at Burton Malkiel’s underlying idea.
Shiller maintains that share prices will rise in anticipation of the companies that do well and pay the biggest dividends, starting from the premise that share prices are much more volatile than dividends, and that share prices are driven by pure psychology, which isn’t always rational.
See also: What liquid and illiquid assets are: definition and explanation
Somewhere between these ambiguous and conflicting ideas lies the underlying value of companies: according to Graham, Warren Buffett’s teacher, sooner or later the market will give a company the value it deserves.
In short, when I recommend these two books, together with Benjamin Graham’s The Intelligent Investor, all I want is for investors to grasp one idea: the market (investors as a whole) has its moments of irrationality. You, as an investor, must be rational at all times. And mind you, being rational doesn’t mean you have to be a fortune-teller, because simply trying to guess the future isn’t rational.
Featured image: SystemBuilder at English Wikipedia, CC BY-SA 3.0, via Wikimedia Commons.
