The Four Pillars of Investing | William Bernstein

Before trying to tell you what to do, Bernstein addresses some of the reasons of ‘Why’ and ‘How’ behind investing. He introduces market theory, discusses the history of investing, and explains the influence of human psychology and the very real impact of the media – identifying how we are often our own worst enemy when it comes to investing.

A young person saving for retirement should get down on their knees and pray for a market crash, so that they can purchase their nest egg at fire-sale prices.

William Bernstein
four pillars of investing

Short summary of the four pillars of investing

Bernstein has one key difference to many economic and finance professionals; he believes the market is not truly efficient and that you can beat the market and get returns higher than a total market stock index fund would.. How? Not by individually picking stocks, but instead by weighting your portfolio towards small cap stocks (smaller or newer companies) such as by using a small cap stock index ETF. This goes against advice of many investing heavy weights such as Berkshire Hathaway’s Warren Buffet and Vanguard’s John Bogle, who both advocate an efficient market and thus holding the entire market in a total stock index fund

Apart from this small difference, Bernstein hits the nail on the head, advocating;

  • Diversification
  • Passively managed Index funds
  • Buy-and-hold for the long term strategy
  • Reducing your investment costs

Bernstein advocates a portfolio to include a percentage of bonds (with maturity dates between 1-5 years) equal to the investors age. This is something I don’t agree with, because I can’t quite yet see the value of Bonds myself.

The Four Pillars of Investing

The Four pillars of investing are: Theory, History, Psychology and Business.

Pillar 1: Investment Theory

Bernstein explains in the first pillar of investing how high returns require high risk, why the market is efficient and how you can benefit by indexing to own it all. He explains how building a portfolio consisting of US total stock market index funds, US small-cap index funds and International total stock market index funds provides the safest long term return. An example is that high previous returns usually indicate low future returns and vice versa.

Pillar 2: Investment History

Bernstein discusses the history of the stock market, including the various crashes and downturns, and how despite all this the total stock market index constantly reaches new all-time highs. Bernstein covers the Mississippi Bubble, Railway Mania,

Pillar 3: Investment Psychology

Pillar three discusses investment psychology and how in the long term, we need to ditch out emotions and invest according to long term results. He discusses the fallacy of seeing patterns in completely random returns, and how media sensationalism allows day traders to prey on the fear or panic of shortsighted investors. Bernstein explains how the most boring investments typically have the highest long term returns, so you should be happy with ‘boring’ old investments and getting rich slowly.

Pillar 4: Investment Business

Your investments should be made just like a business. Cash flow and fees are important; so you need to pay significant attention to your investment costs. Brokerage is a direct cost, but management expense ratios in ETF and managed funds can be a silent killer. On average, 40% of returns investors gain are gobbled up by excessive management and ‘performance’ fees by fund managers. Furthermore, as discussed in Pillar three, you should ignore all investing media due to vested interests. Focus on solid business fundamentals and long term data to invest successfully.

“Wealthy investors need to realise they’re the cash cows of the investment industry and are regularly fleeced

William Bernstein

Essentially you cant control the returns of the market, but you can control your spending (so you can invest more frequently), the fees you pay, and increasing your diversification with smart asset allocation.

Why The Four Pillars of Investing is applicable to Financial Independence

Those on the path to financial independence have two main ways to reach their goal – they are to spend less, and to earn more. The primary goal of earning in FI is to produce passive income, which can be derived from smart investing. Understanding Bernsteins four pillars therefore is a massive advantage to someone wanting to become financially independent and make smart investments. Bernstein provides numerous tips and practical advice on investing, especially on the topic of avoiding common traps for investors such as high management fees.

The Captains big takeaways

  • Don’t get ANY investing advice from the media. In fact switch off your TV now
  • You need to understand how the stock market works, particularly how index funds are structured and the role of accounting firms in generating and indexes which investment companies then attempt to track.
  • Realise that a high Management cost, Account fee, Performance fee etc or however the word ‘fee’ is disguised or tarted up, will seriously erode your returns. You can’t control the market but you CAN control the fees you pay
  • If you don’t understand and learn from the past you are destined to make the same investing mistakes in the future.

Where to get a copy of The Four Pillars of Investing

Check it out on Amazon here, listen to it through Audible or buy it from Australia’s local bookstore Booktopia

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