Investing Books by William J. Bernstein
review by J. Zimmerman

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	The Four Pillars of Investing : Lessons for Building a Winning Portfolio by William J. Bernstein. Explains how to construct an investment portfolio that will let you sleep at night, give you a return on your investment, and protect you from the sharks of the financial community. John Bogle selected this book as the best investment book for 2002. And I agree with John Bogle on this. Read more on The Four Pillars of Investing.
	The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by Neurologist William J. Bernstein Read more on The Intelligent Asset Allocator.
	Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor by John C. Bogle. And see our review.
	The Great Unraveling: Losing Our Way in the New Century by Paul Krugman And see our review.

The Four Pillars of Investing: Lessons for Building a Winning Portfolio

The Four Pillars of Investing is an easy and educational recipe book for creating long-term investing success.

What are the Four Pillars?

1. Theory (understanding the inherent risk associated with high returns). One of its chapters is "No Guts, No Glory."
2. History (to prepare you for the inevitable madnesses of markets). This section gives you: "Tops: A History of Manias" and "Bottoms: The Agony and the Opportunity."
3. Psychology (how to benefit from the usually erroneous 'conventional wisdom' of the market). It discusses: "Misbehavior" and "Behavioral Therapy."
4. Business (how stockbrokers and others see their clients as cash cows, and ways the world works). One of its chapters is "Your Broker is not your Buddy."

• Will You Have Enough?

Assembling the Four Pillars: Portfolio Design.

Bernstein shows examples of historical data that indicate how funds in 1965 of a million dollars would be exhausted in the 1970's or 1980's if one withdrew more than forty thousand dollars annually. And even at forty thousand dollars, the funds would be exhausted soon after that unless half were in stock.

In particular, if you experience a row of poor returns in the market, you may run out of money before the market can rebound. He also suggests that you not invest in stocks money that you will need in less than five years.

Bernstein shows a table that let you figure out, depending upon what you believe you are willing to lose, how much to invest in the stock market. For example, if you can tolerate losing 10%, then put no more than 30% in stocks; if you can tolerate losing 20%, then put no more than 50% in stocks.

His practical advice includes suggestions of deciding which asset classes and in what portions to put into portfolios for people in different circumstances.

For example, for "Mr. Taxable" - a person without pension fund or IRA - Bernstein suggests this mix for stock allocation:

15% Vanguard REIT (in a Variable Annuity (despite its expense) to defer tax). 20% Vanguard Tax-Managed Small-Cap. 25% Vanguard Tax-Managed International. 40% Vanguard Total Stock Market (large-cap).

and this mix for bond allocation:

25% Treasury ladder. 25% Vanguard California (or his state) Intermediate-Term Tax-Exempt. 25% Vanguard Limited-Term Tax-Exempt. 25% Vanguard Short-Term Corporate Bond.

Bernstein's other sample portfolios show candidate allocations for:

• a sheltered investor who is moving all his assets out of taxable savings into retirement assets.
• an investor with a 10%-sheltered (i.e., a partially sheltered) portfolio.
• a young investor just beginning a retirement plan.

For a person whose assets have all been moved into retirement assets (having spent his taxable funds), Bernstein points out that the investor has more flexibility than an investor without sheltered funds. This is a sample mix for stock allocation of sheltered funds:

20% Vanguard 500 Index. 05% Vanguard Emerging Stock Markets Index. 05% Vanguard European Stock Index. 07% Vanguard International Value. 05% Vanguard Pacific Stock Index. 03% Vanguard Precious Metals. 10% Vanguard REIT Index. 05% Vanguard Small-Cap Index. 15% Vanguard Small-Cap Value Index. 25% Vanguard Value Index.

and this mix for bond allocation:

60% Vanguard Short-Term Corporate Bond. 40% TIPS (Treasury Inflation Protected Security).

After looking at those two extremes, it's useful for most of us to look at an intermediate position, which is what applies to so many of us.

For example, Bernstein summarizes that choices of a sample woman with a partially (10%) sheltered portfolio. She decides to split her money equally in stocks and bonds.

For most advantage of the sheltered 10% of her portfolio, she puts it all into value stock, which thus uses 20% of her stock investment:

10% Vanguard REIT Index (reluctantly, in VA). 30% Vanguard Tax-Managed Growth and Income. 25% Vanguard Tax-Managed International. 15% Vanguard Tax-Managed Small-Cap. 10% Vanguard Small-Cap Value Index (IRA). 10% Vanguard Value Index (IRA).

Her bond fund allocation is the same as for Mr. Taxable. Remember to use the fund for bonds of the state in which you reside.

The Four Pillars of Investing : Lessons for Building a Winning Portfolio by William J. Bernstein.

The book can show you:

• How to mix asset classes into an effective blend of investments.
• Why it is less dangerous to invest in the whole market instead of individual stocks.
• How one's state of mind can affect one's decisions for the worse.
• Why the brokerage industry and even the mutual fund industry are often in competition with you.
• Strategies for managing all of your assets as one portfolio.

Highly recommended!

The Intelligent Asset Allocator

The Intelligent Asset Allocator is a more mathematical and theoretical book, to help you see the underpinnings for creating long-term investing success.

Another recommended gem by William J. Bernstein.

Other books and reviews:

The Great Unraveling: Losing our Way in the New Century by Paul Krugman (Op-Ed Columnist for The New York Times).	Check our review of The Great Unraveling by Paul Krugman.
Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor by John C. Bogle.	Check our review of Common Sense on Mutual Funds by John C. Bogle.

John C. Bogle's Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor.
review by J. Zimmerman

Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor by John C. Bogle is a logical plan for the individual investor and for the fund industry, written by the founder of the Vanguard Group. As such, he is a strong advocate of low-cost funds in general and indexed funds in particular.

His book will convince most intelligent and unbiased readers of the wisdom of this position. Especially he does this by his generous supply of graphs that give the reader a quick sense of much of the data that support and illustrate his statements.

We encourage you to buy this book. To whet your appetite, here are some of interesting points.

Years before the 2003 scandal of market timing for favored customers, Mr. Bogle wrote:

"Sadly, as the figures on fund portfolio turnover show, ... Industry practice today is as close to short-term speculation - and as far from long-term investment - as the law allows. " [p.28] "Market timing an rapid turnover - both by and for mutual fund investors - betray both a lack of understanding of the economics of investing and an infatuation with the process of investing. " [p.29]

Bogle advises "a few simple rules" [p.31]:

• You must invest and put your money to work for you.
• Time is your friend. Invest early even if you invest very little.
• Eliminate emotion from your investment program. Be rational about expectations that you can maintain through the switches between summer and winter in the behavior of investments.
• For simplicity, he tells his readers to decide on a "sensible" allocation of your investments among stocks, bonds, and cash; on middle-of-the-road funds that concentrate on high-grade securities; and on a careful balance of risk, return, and cost.

1. Dividend yield at initial investment.
2. Subsequent rate of growth of earnings.
3. Change in Price-Earnings ratio during the investment period.

• "Irrespective of what the future holds, ... equities should remain ... the dominant component of a well-balanced asset allocation program."

Bogel is concerned that his readers understand the variations in Equity Fund Expenses, showing that cost as well as asset allocation determines performance. He writes:

1. As an annual percent of assets, costs range from 0.2% to 2.2%.
2. However, what that means as a portion of an annual percent of a 10% return, is that costs range from 2% to 22%.
3. Those expenses over 10 years are from 2.8% to 28.1% of the initial investment.
4. This expense corresponds to a percentage of the equity risk premium (an interesting new way of looking at your expenses!) of 6% to 63%.

In his emphasis on simplicity, Bogel recommends:

1. Select low-cost funds.
2. Consider carefully the added costs of advice.
3. Do not overrate past fund performance. In particular: "Funds with past relative returns that have been substantially superior to the returns of an appropriate market index will regress toward, and usually below, the market mean over time." He shows that 97% of the funds in the top quartile for 1970's and 1980's showed this reversion, as did 100% of the funds in the top quartile for 1987-1997.

   "The mutual fund industry is well aware that nearly all top performers eventually lose their edge."

4. However, do use past performance to estimate consistency and risk. Also using Morningstar risk ratings ("based on a fund's returns in the months in which it underperformed the risk-free U.S. Treasury bill"). "The risk of the average large-cap fund (22% below average) has carried only half the risk of its small-cap growth fund counterpart (93% above average). He cites Morningstar risk for the 9 combinations of 3 capitalizations and 3 styles, where the average fund has a risk of 100:

   Capitalization	Value Style	Blend Style	Growth Style
   Large	78	84	114
   Medium	85	105	156
   Small	104	140	193

5. "Beware of stars" whether portfolio managers or fund-rating stars.
6. "Beware of asset size." Problems related to the growth of a fund's size may be visible in the declining trend of a fund through the quartiles of relative performance.
7. "Don't own too many funds." Morningstar is cited as showing that "owning more than four randomly chosen equity funds does not reduce risk appreciably."
8. Once you have decided on your portfolio allocation, buy it and hold it. Thereafter, for possible rebalancing: "an annual performance appraisal ought to be just fine."

Other advice includes:

• Don't fight last year's war. Don't assume that any trend lasts forever. History gives you perspective but you should make your investment decisions on the present conditions.
• Related to that, be alert to the Power of the Mean. This magnet pulls on financial markets (as on much else in our lives). Bernstein sees such regression to the mean as a law of the financial jungle, and something that lets us expect returns to deteriorate, for any portion of the market that has exceeded historical norms by significant margins. And the reverse.
• Beware of acting on insights of the market that you think are yours alone. Millions of investors are likely to know something that you believe you are discovering.
• Don't overestimate your ability to pick superior equity mutual funds.
• However, don't underestimate your ability to pick superior bond and money market funds. Most of the difference in performance among comparable funds appears due to differences in their operating expenses.

Mr. Bogel has much more advice and many more warnings. Read his book before you buy a broker-distributed high-cost bond fund for example.

So you can see what you get in Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor here are its contents:

On Investment Strategy. 1. On Long-term Investing. 2. On the Nature of Returns. 3. On Asset Allocation. 4. On Simplicity: How to come down to where you ought to be. On Investment Choices. 5. On Indexing: The Triumph of Experience over hope. 6. On Equity Styles. 7. On Bonds. 8. On Global Investing. 9. On Selecting Superior Funds: The Search for the Holy Grail. On Investment Performance. 10. On Reversion to the Mean. 11. On Investment Relativism. 12. On Asset Size. 13. On Taxes. 14. On Time. On Fund Management. 15. On Principles. 16. On Marketing. 17. On Technology. 18. On Directors. 19. On Structure. On Spirit. 20. On Entrepreneurship. 21. On Leadership. 22. On Human Beings.

Also see the modestly named: The Only Guide to a Winning Investment Strategy You'll Ever Need by the modest Larry E. Swedroe.

Another proponent of long-term investment in index funds, Swedroe suggests how to select a "balanced passive portfolio for the long haul". The first 2 chapters report how active portfolio management eats up your savings. The next 4 chapters discuss efficient markets and modern portfolio theory. The last 5 chapters discuss how to make efficient portfolio theory work for you

Chapter 5 (p.132) shows an interesting chart based on historic data showing the risk premium for various asset classes compared to the 5-year treasury note. They do not, however, show the volatility (or risk) in the asset classes:

Asset Class "Risk Premium" With this Extra gain i.e., historical increase of Allocation -> of portfolio return over 5-yr. treasury. Short-term fixed 0.0% 25% -> 0.0% Long-term fixed 1.5% 25% -> 0.4% Large cap 5.0% 10% -> 0.5% Small cap 10.0% 10% -> 1.0% Value 10.0% 10% -> 1.0% Small cap Value 15.0% 10% -> 3.0%

Chapter 7 (Six Steps to a Diversified Portfolio) has a practical demonstration of the merit of diversification.

• Start with Portfolio 1 of 60% S&P 500 Index and 40% Lehman Government/Corporate Bond Index.
• Portfolio 2 adds international stock, with 15% in EAFE (Europe, Australia, and Far East) Index; 45% S&P 500 Index; 40% Lehman Government/Corporate Bond Index.
• Portfolio 3 adds small company asset class, with 15% in this class; 30% S&P 500 Index; 15% in EAFE; 40% Lehman Government/Corporate Bond Index.
• Portfolio 4 adds value stock, with 7% in small value and 15% in large value; 15% S&P 500 Index; 15% in EAFE; 8% small company; 40% Lehman Government/Corporate Bond Index.
• He continues through other additions.

Portfolio 1975-1995 1975-1995 Annualized Return. Annualized Standard Deviation Portfolio 1 13.5% 10.5% Portfolio 2 13.8% 9.9% Portfolio 3 14.5% 10.0% Portfolio 4 15.3% 10.2% Portfolio 5 16.3% 9.9% Portfolio 6 16.1% 8.7%

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