Saturday 2011-02-12

The Four Pillars of Investing by William Bernstein

Remember back in school when there was at least one kid who was really good with factoids, and also had real difficulty with big concepts? Bernstein seems like that kid.

Bernstein lists the four pillars as: Theory, History, Psychology, and the Business, where theory means Efficient Market Theory, History = manias and panics, Psychology = intro to irrationality, and Business indicts the investment ecosystem (save Bogle's Vanguard).

He alters Ben Graham's margin of safety argument into "buy when it looks historically cheap" and marries it to Efficient Market Theory's portfolio design. He acknowledges survivorship bias in other sections, however here he ignores it as this algorithm works for countries / industries / companies that still exist.

He provides no data on a portfolio of out of favor investments, however just a brief survey of American companies reveals lots of dead companies and not so many live ones. And of the dead, many were historically cheap just prior to expiration.

Flaws in analysis exist throughout the text; which hurts because he has read a great deal of the extant classic investment books, and he writes reasonably well to boot.

However, all this seems unnecessary as his advice boils down to: start saving your money and buy Vanguard funds with some exposure to create a balanced portfolio of bonds and equities.

It is not possible to precisely predict the future, but a knowledge of the past often allows us to identify financial risk in the here and now. Returns are uncertain. But risks, at least, can be controlled.
-- No Guts, No Glory
He (Alfred Cowles III) was the first financial economist to make use of the new punch card machines eing produced by the Hollerith Corporation. (Another investment giant, Benjamin Graham, also had a connection with Hollerith. As a young analyst in the 1920s, he almost lost his first job by recommending that his conservative employer purchase stock in the company. A few years later, Hollerith decided that a more modern-sounding name would be appropriate: International Business Machines
-- The Market Is Smarter Than You Are
In 1687, William Phipps, a New England sea captain, docked in England with 32 tons of silver raised from a Spanish pirate ship, enriching himself, his crew, and his backers beyond their wildest dreams. This captured the imagination of the investing public and before long, numerous patents were granted for various types of "diving engines".
-- Tops: A History of Manias
Reporting the fiasco (European Railroad bust), the Times of London introducted the word "bubble" into popular financial lexicon when it proclaimed, "A mighty bubble of wealth is blown away before our eyes." The rapid contraction of liquidity cascaded through the British financial world in the following years, almost taking the Bank of England with it. Even consols fell; only gold provided a safe haven.
-- Tops: A History of Manias
Of all history's great bubbles, the 1920s bull market was the most "rational". Between 1920 and 1929, real GDP rose almost 50%, seemingly confirming the optimists' predictions of a "new era" born of scientific progress. Further, by today's standards, stocks were positively cheap. Until 1928, they sold at approximately ten times earnings and yielded about 5% in dividends. Even at the peak, in the summer of 1929, stocks fetched just 20 times earnings, and dividends fell only to 3%.
-- Tops: A History of Manias
When this happens, keep a close hold on your wallet and remember John Templeton's famous warning: The four most expensive words in the English language are, "This time, it's different."
-- Tops: A History of Manias
The political reaction to the South Seas Bubble was violent. Many of the company's directors, including 4 MPs, were sent to the Tower. Most of their profits were confiscated, despite the fact that such a seizure of assets was a violation of common law. ...
Parliament almost outlawed stockbrokering and made illegal short sales, futures, and options.
-- Bottoms: The Agony and the Opportunity
there are tens of thousands of professional investors using the kind of software, hardware, data, technical support, and underlying research that you and I can only dream of. When you buy and sell stock, you're most likely trading with them. You have as much chance of consistently beating these folks as you have of starting at wide receiver for the Broncos.
-- Misbehavior
So many things wrong here:
1. Be a good little sheep, and no one gets hurt.
2. That technical support clinches it.
3. Wait, so you're telling me there's a chance? YES!!!
I don't envy financial journalists. These benighted folks have to come up with fresh copy every week, and in some cases, every day.
-- Misbehavior

Bernstein has an increasingly sparse blog at I haven't read the book, the most of the articles follow your description of the book - they push Vanguard and especially DFA (based on French and Fama's 3 factor analysis). The articles were pretty interesting at the time I read them, but it's been a while. --Theo