The Four Pillars of Investing

William Bernstein

 (2002)

William Bernstein, market historian, scholar, and strategist, writes this new book with the confidence of his experience and the courage of his convictions, just as he did in his earlier “The Intelligent Asset Allocator.”  The work is an expansion on the theme that you cannot beat the market by timing or hiring active professional fund managers, so allocate, sit back, and enjoy the long-term ride. His advice is equally applicable to the novice as well as the veteran investor. You get a short course on what market returns you should expect, why you cannot beat the market, why the professionals can’t help you, and how to set up your own portfolio using index funds. In other words, he has no use for the investment business other than the index funds it produces.

Chapter 5 on Manias is an excellent history of economic progress, and obviously the groundwork that led to his soon-to-be-published “The Birth of Plenty” (mid-2004) on the origins of the West’s affluence. I particularly appreciated his credit to Hyman Minsky on the pattern of bubbles. Although Kindleberger has covered much of the same ground and with greater visibility in the press, Minsky’s contributions are more insightful to understanding the distinct nature of economic manias.

Another interesting tidbit is his portrayal of technology as being, in general, a bad business endeavor. Bill Fleckenstein has made this point frequently that technology, unlike Buffett’s desired “consumer monopoly,” is easily outmoded and supplanted with the new, new thing. Let’s just be thankful that earlier entrepreneurs took the time and the risk to create progress.

The true worth of the book comes under the heading of  “Why investors lose money.” This is the cornerstone of Bernstein’s philosophy stating that if you can keep from losing, you will win:

(1) Instead of joining the herd mentality, get out when “everybody” knows that something is a good thing. It only means that everyone who wanted to buy already has; there are no buyers left. Prices can only fall.

(2) Overcome overconfidence by checking the performance figures. Few professionals ever “beat the market.” Why do you think you can?

(3) Understand that all investments return to the mean, thus past performance is no indication of future performance.

(4) Don’t trade for excitement. Look elsewhere for entertainment.

(5) Keep your eye on the long term and don’t be panicked out by emotional short term swings.

(6) Realize that there are no “great companies." The 1000+% returns are few and far between.

(7)  Accept that the market is random. Therefore don’t get fooled into believing patterns repeat. Index funds are the only way to go.

(8) Check your accounting carefully. Don’t overstate your successes while forgetting your losses. Keep track of the total return.

(9) Don’t get taken for a ride by the investment industry. Trust no one.

It gets a little trickier when he begins building portfolios. Using representative stereotypes, he sets up hypothetical investments using US stock index funds made up of large caps, small caps, large value, small value, REITs, and Foreign securities. The remaining assets should be split up between cash and bonds (long and short). Your results will be dependent on how well you can approximate this theories. Another catch comes with “rebalancing.” Bernstein’s advice here is also well taken. Sell out a portion of the superior performers to bring your percentages back in line to their desired weight in the portfolio and re-allocate those funds into the underperformers to bring their numbers up to desired percentages. Regardless of his distain for decision making, this does require skill and action on your part, but Bernstein has given you enough help to get the job done correctly.