Andrew Allentuck

Monday, May 21, 2002


The Four Pillars of Investing: Lessons for Building a Winning Portfolio
by William J. Bernstein
McGraw-Hill, 2002
316 pages
ISBN 0-07-138529-0

This book is what the title says but much more. Author William Bernstein, a physician with a deep knowledge of finance, takes the reader from the most basic principles of risk and return to portfolio selection. On the way, he considers his four pillars (investment theory, financial history, market psychology, and business organization).

Dr. Bernstein observes, as many others have, that stocks outperform bonds. Not only have they done so over time, but they must do so, for stocks eliminate volatility over time by producing returns that regress to the mean of their asset class and market, just as markets tend to average out returns for their own levels of risk. Bonds, on the other hand, tend not to produce returns that regress to the mean. In practice, that means that sticking with stocks will get you to the average level of return appropriate to the risk of your portfolio, while bonds can go through many bad successive periods, as they have often done since 1900.

This is much the same pitch that Dr. Bernstein made in his previous book, The Intelligent Asset Allocator, but this book is addressed to a broader kind of portfolio construction and management and, above all, to the novice investor. "The stockbroker services his clients the same way that Bonnie and Clyde serviced banks....He also occupies the lowest rung of investment knowledge." Writing like this you don't get in conventional treatises on how easy it supposedly is to make money on stocks.

There are lessons that are written in stone, Dr. Bernstein says, and the wise investor must observe them:

  1. You don't get high returns without high risks.
  2. Markets go nuts once in a while. Avoid buying in manias and be ready to buy when investors are ready to jump off ledges. Returns will regress to the mean for those with the guts to buy in panics.
  3. When you examine markets, use the longest data periods possible. Ingnore the last five or ten years.
  4. Brokers are crooks.
  5. You learn nothing from newspapers and magazines and t.v. financial reporting is bunk.

Dr. Bernstein says that a solid portfolio can be built out of domestic and foreign stocks, some real estate investment trusts, and perhaps by segmenting domestic stocks into large cap, small cap, large value and small value. He has no use for growth stocks and thinks that growth investors are due to go bankrupt.

This is opinionated stuff written by a man of immense knowledge and an acid wit. He's a knight in shining intellect for the ordinary investor, enemy of managers with high fee funds, exposer of idiocy, and, above all, a market theorist who is due to become a legend. As an investment thinker, he is in the same class as Warren Buffet and even of Ben Graham. The beginning investor can read this with benefit and even very experienced investors will find much value in what Dr. Bernstein has to say.