The Four Pillars of Investing

I am currently reading "A Splendid Exchange" written by William Bernstein so I decided to post notes I previously put together on another of his books: "The Four Pillars of Investing" that I read in 2006. This was before I began posting my notes to my blog-site. His advice given in 2002 is still mostly valid in today's tumultuous times. Bernstein is a financial theorist and historian.





William J. Bernstein, “The Four Pillars of Investing: Lessons for Building a Winning Portfolio,” McGraw-Hill, 2002

Bernstein states that Successful investments are built upon four “pillars”:
• a knowledge of investment theory
• an understanding of the history of investing
• insight into the psychology of investing
• an awareness of the business of investing

An adequate portfolio need contain only three broad asset classes: U.S. total stock market, international stocks, and short-term U.S. bonds. (For those retired I would add cash intruments such as CD's). For the U.S. stock portion, he recommends five asset classes: large-cap, small-cap, large-cap value and small-cap value, and real estate investment trusts (REITs). Since large value and small value indexes tend to contain both value and blend stocks, his value tilt is more precisely a tilt against growth stocks.

For the bond portfolio, his overriding principle is to select short-term—five years or less—high-grade bonds. One solution would be to buy two-year Treasuries direct from the government at auction, thereby minimizing investment expenses. (For now I would stay out of bonds as interest rates can only go up; TIPS are a viable alternative).

Concerning the selection of mutual funds, he recommends only no-load low-cost funds, primarily index funds. He provides a list of recommended funds by asset class.
The theory section emphasizes the long-run connection between risk and return. The history section notes the tendency for financial markets to go berserk about once a generation, and the need to keep your wits about you during these episodes. The psychology section reviews key psychological mistakes many investors make and how to avoid them.

The section on the business of investing is worth the price of the book. A chapter entitled “Your Broker Is Not Your Buddy” warns that “under no circumstances should you have anything to do with a ‘full-service’ brokerage firm.” The next chapter entitled “Neither Is Your Mutual Fund” explains the chicanery that goes on at some mutual fund families.

For additional information, visit the author’s Web site at www.efficientfrontier.com. William Bernstein has also written “The Intelligent Asset Allocator” (McGraw-Hill, 2000). It covers most of the same topics but at a more rigorous level.