William J. Bernstein’s 2002 book, The Four Pillars of Investing: Lessons for Building a Winning Portfolio, has become a guide for self-directed investors.
The time of dreams
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The key to portfolio design is not to maximize profits in average markets, but to survive terrible markets, says financial author William J. Bernstein.
“If you design your portfolio to survive the worst 2% of the time, that means it’s going to be more conservative than you think,” he said. Barrons. But after 50 years of preparation, “you’ll be glad you did.”
Bernstein became an icon for self-directed investors with the 2002 publication of The Four Pillars of Investing: Lessons for Building a Winning Portfolio. The book explained how to use low-cost index funds to build and maintain sustainable investment portfolios.
Bernstein has spent the last year researching and writing a new version of the book, which comes out this month.
He says he puts more emphasis in the new book on having bulletproof wallets that survive terrible markets than in the first edition. He used to recommend that ordinary investors hold corporate bonds through mutual funds because they pay more than treasury bills. He doesn’t do that anymore. Indeed, in catastrophic markets, corporate bond prices fall along with equity prices as investors worry about credit losses. Treasuries, on the other hand, tend to rise when stocks fall.
“You want the risk-free part of your portfolio to be absolutely risk-free,” says Bernstein. “Corporate bonds really have no place in your portfolio.”
Bernstein wants to avoid losses in his safe capital, so he won’t have to sell losing investments to buy stocks during stock market crashes. “It’s never easy to buy stocks at rock bottom, and it’s especially difficult if you have to get a haircut to do it.”
The time Treasuries fall is when interest rates soar, as they did last year, leading to epic bond losses. Bernstein preached for years that investors could protect themselves from this outcome by keeping their money in short-term Treasuries rather than longer-term Treasuries.
He continues: “There is a reason why Warren Buffett has 20% of
Berkshire Hathaway
in cash or near cash.
Bernstein, a neurologist, practiced medicine for 25 years before becoming a full-time financial and historical author and fund manager in 2005.
He is well versed in the mathematics of investing and his latest book contains detailed mathematical explanations for those who wish. Still, Bernstein says those who view investing as a purely mathematical exercise are going to be deeply shocked. Market psychology is equally important and helps explain why markets can behave in ways that mathematical models cannot predict.
“History tells you markets can be a cruel mistress,” he says.
Ordinary investors tend to overestimate their tolerance for risk, Bernstein says. “They say, ‘I can tolerate a 60/40 mix of stocks and bonds. I can tolerate a 30% drop in my portfolio.’ But when it actually happens is another thing.
The goal of investing for most people should be to avoid poverty, not to get rich, Bernstein says. He begins his book by talking about long-term capital management, which was pioneered by recognized market experts, including two Nobel Prize-winning economists in the 1990s. The company aimed to profit from a strategy of complex derivative-based trading that was leveraged 25 to 1 with borrowed funds. “It quadrupled investors’ money over a four-year period before it imploded,” Bernstein writes.
He compares this celebrated extinction with Sylvia Bloom, a legal secretary who spent 67 years working at a New York law firm and left behind a $9 million estate. She did this simply by investing in common stocks and letting her money accumulate over a long period of time.
“The slower you drive, the more likely your assets are to arrive safely at your destination,” Bernstein wrote. “That’s what Bloom did with his money; The leaders of LTCM, to their detriment and that of their investors, have set foot in the stirrup.
Ordinary Investors Can Learn From Long Term Capital’s Collapse, Bernstein Says Barrons. “The name of the game with investing is not to get rich, but to avoid getting poor. If you want to get rich, you want to buy the next
Apple
or the next
Nvidia
,
and that’s not a good way. Because 99% of the time, the company that looks like the next Nvidia or the next Apple is going to sink like a stone.
Bernstein has written extensively on financial history, and in his latest book he discusses all the different bubbles and scams over the years and what they tell us about the psychology of the market. Bernstein warns investors to beware of flashy people peddling various get-rich-quick schemes.
“If you’re persuasive and eloquent,” Bernstein says, “the temptation to monetize it in the world of finance is irresistible.”
He adds, “The people I respect the most are almost universally bad speakers.”
Write to Neal Templin at neal.templin@barrons.com