Rapid-fire computer trading can trigger short-term volatility but shouldn’t discourage individuals from investing in the stock market and ETFs, says indexing proponent Burton Malkiel.
“Investors saving for retirement have no reason to fear day-to-day or week-to-week volatility,” Malkiel wrote in an op-ed Tuesday for The Wall Street Journal. “The correct response is not to ‘do something’ but rather to ‘just stand there.’ Evidence continues to accumulate that the long-term investor who simply buys and holds low-cost broad-based index funds and (indexed) ETFs does not achieve mediocre returns but well-above-average returns.”
Malkiel is the author of “A Random Walk Down Wall Street” and a former director at index fund and ETF manager Vanguard Group.
Investor confidence in markets has been shaken by the 2010 “flash crash” and the recent Knight Capital Group software glitch that temporarily roiled trading in individual stocks, and spilled over into ETFs. [Five Lessons for ETF Investors After the Knight Meltdown]
“What about Knight’s role as a market maker in the broad-based ETFs that I have long favored for individual investors? Bid-asked spreads (and therefore transactions costs) temporarily increased as Knight stepped away from the markets. But those spreads attracted other market makers and traders as profit-seekers pounced on the opportunities to offer slightly better prices,” Malkiel wrote in the WSJ piece. [Knight, ETFs Recover After Software Trading Glitch]
“Again, this is exactly how free markets ought to behave. After a few days the spreads on the most widely traded ETFs returned to normal,” he added. “The conclusion is not that markets failed. On the contrary, the markets punished Knight far more severely than regulators ever could. That’s exactly what the capitalist system is designed to do.” [Trading Disruptions Underline Importance of ETF Market Makers]