It’s safe to say we’ve all been spending more time indoors lately.
In adapting to a new (temporary) normal, many of us are refocusing and recalibrating – video chats with the family, taking a new interest in baking, and reading – a whole lot of reading.
This period of introspection is a good chance to take another look at your investment plan. It’s easy to feel unnerved, or get knocked off course, especially in exceptional circumstances, but even now the fundamental principles remain.
Let’s revisit them in ‘The Four Pillars of Investing’ by William Bernstein.
What makes it great, in a nutshell?
It’s a classic that sets out the theory and practice of portfolios. Known for “questioning the value of Wall Street wisdom and skewering the recommendations of self-serving stockbrokers” Bernstein dispels the myth that investing is only for ‘professionals’. He looks at four fundamental pillars – ‘Theory’, ‘History’, ‘Psychology’ and ‘Business’.
The Theory of Investing
In the first, and longest, section Bernstein explores the importance of holding your nerve and playing the long game. He looks at risk and reward, framing the stock market’s many bad years over the last century in the light of overall long-term gains – as he says, “no guts, no glory”.
Chapters 2 and 3 explore the inherent difficulties of ‘value’ and understanding how it may change over time. Assets move in different directions at different times, and some are more inherently risky than others. He also explains that trying to predict market movements is a fool’s errand – a handful of managers may get ahead for five minutes, but averaging out the performance of all fund managers gives roughly the same returns as the stock market – and that’s before you subtract fees.
In ‘The Perfect Portfolio’ Bernstein sets out his recommendations, his template, for how a healthy, diversified portfolio should look, bringing together the themes of keeping costs low, thinking long term and avoiding attempts to ‘beat the market’. Even if you’re an experienced investor, it’s worth being reminded of these principles.
The History of Investing
In this section we look at ‘tops’ and ‘bottoms’ (if you’re working at home this has nothing to do with pyjamas, we’re talking tops and bottoms of the market).
Here Bernstein looks at ‘bubbles’ – how they begin with a handful of people doing very well and end with a huge number of people trying to follow, which ultimately becomes unsustainable. The ‘bottom’ in question occurs where large numbers of people panic and try to exit in a hurry.
There are two lessons here – first, it makes good sense to buy stocks when everyone else is heading in the other direction. Second, bubbles grow and burst, they always have and always will, so your investment approach should focus on the long term, not ‘the next big thing’, with a diversified portfolio that’s equipped to roll with the punches.
The Psychology of Investing
The third pillar, ‘The Psychology of investing’, looks at our innate character flaws. The subject of behavioural biases is fascinating – we see patterns where there are none, we overweight stocks in familiar sectors or locations and we’re more receptive to ‘evidence’ that backs up our hunches.
Bernstein looks at the “country club effect” – a spectacular piece of keeping-up-with-the-Joneses, in which wealthy people make ill-considered investments simply for the bragging rights.
There’s little we can do to remove our biases, they’re hard-wired, but we can be aware of them. Confidence is good, but question it. If everyone else is doing the same thing, ask why. Most importantly, “be boring” – with investment, excitement is the one thing you don’t want.
The Business of Investing
In the final pillar of Bernstein’s quartet he really sells the value of index funds, pointing out that active funds have managers to keep happy and marketing to pay for (with your returns footing the bill). Index funds have neither – there’s no manager and their strategy is refreshingly simple.
He also takes aim at stockbrokers, encouraging a DIY approach, a theme he continues in Chapter 11, in which he sets out the importance of educating yourself about how investing really works and practicing discipline – leaving your investments to do their thing.
What does the book teach us?
In the remaining chapters, Bernstein draws together his four pillars, looking at how they can form the basis of your own investment plan, getting started, staying on track and letting your money grow in the long term.
He returns to the theme of ideal portfolio construction, recommending an ongoing frugal approach in which you’re assured of having enough money for retirement –when you get there and for as long as it lasts.
Whether you’re just starting out or you’ve been investing for years, it’s a great place to start or a good way to reacquaint yourself with the fundamentals. Bernstein reminds us that whatever’s going on around us, the basic maths and principles of investing hold true. It’s a primer for good portfolio construction and a healthy refresher for investors of all levels.