The Four Pillars of Investing According to William Bernstein

Avoid the pitfalls that trap lousy investors

About The Four Pillars of Investing

In William Bernstein's Four Pillars of Investing, he tells readers how to build an investment portfolio meant to win in the long run. He doesn't tell you what to buy... Which is what many people want. But he explains fundamental concepts to help investors make smarter investing choices on their own. 

The phrase "if you give a man a fish, you feed him for a day. But if you teach him how to fish, you'll feed him for a lifetime." 

This book teaches you how to invest... It doesn't tell you want to buy. 

Bernstein does that by giving readers the four pillars framework. Those include:

1. Basic knowledge of investment theory

2. Understanding of the history of investing

3. Psychological aspects of investing

4. An inside look of the business of investing... How Wall Street takes our money

About William J. Bernstein

William Bernstein is one of America’s most respected investment writers. Although if you've read one of his books, you've pretty much read them all. 

He focuses on building a bulletproof portfolio of indexes match the financial market's returns over the long-run. He believes the average investor should focus on allocating between asset classes, rather than selecting individual stocks or bonds. 

Bernstein is a strong supporter of the modern portfolio theory. This theory says there is a perfect portfolio of assets that maximizes returns given a certain level of risk. 

Here at barbellalpha.com, we don't believe that to be the case. We're living proof of the fact the individual investor can take money out of the markets. But it takes time, research, and discipline to do so. Something most people don't have.

So if you want to work and follow the conventional wisdom, this is for you. You can then let the power of compounding slowly build your wealth over the next 30 - 40 years. 

Everyone else should get a good refresher of the capital markets from reading this book.

Pillar One: The Theory of Investing

The theory of investing states that there are three factors that make up the foundation of successful investments: risk, return, and diversification.

Risk refers to how much potential loss you're willing to accept. Return is what you hope to gain from your investment. And diversification is about spreading your money around different types of assets.

But investors need to accept a level of risk if they want even average stock returns. Risky assets tend come with higher investment returns. 

He also notes that past performance doesn't always predict future returns. But it does help us understand why certain strategies work better than others.

His studies find that short-term returns from the average person are random at best. 

And he found that even professional money managers often can't beat the market. 

Index funds or passive mutual funds beat active management over the long term. This is because index fund managers don't try to pick individual stocks; rather, they buy a basket of stocks that track a particular benchmark like the S&P 500.

Active management is a waste of your time. You'll never find a strategy that consistently outperforms the market. So why bother trying?

Pillar Two: The History of Investing

Financial history is an important part in investing. In fact, it’s one of the most important parts. You want to know how much money you’re losing every month, what types of investments are working, and whether there are any red flags that could lead to trouble down the road.

But financial history isn’t just about numbers; it’s about understanding why things happen. And while you might think that learning about the past is easy, you’d be wrong.

The problem is that people tend to forget the lessons of the past because we don’t like to admit our mistakes. We prefer to look forward rather than backward, even though looking ahead is far easier. This leads us to make decisions based on emotions—which is never good. Instead, we should learn from the mistakes of others. If you do, you won’t repeat those mistakes yourself.

And the mistakes investors made in the 20th century, and even the 19th century, are getting made again. Human nature never changes... Which gets us into the next pillar.

Pillar Three: The Psychology of Investing

Investors are often too emotionally attached to individual stocks and sectors, leading them to make poor investment choices. This is known as overconfidence bias. Overconfident investors tend to focus on short term trends rather than longer term fundamentals. In addition, they tend to ignore risk factors such as volatility and correlation. They think they have a diversified financial portfolio when they actually don't.

The biggest risk most investors face are not a brutal bear markets, bad companies, or cheap stocks getting cheaper. But it's the choices they make in uncertain times. This is the foundation of behavioral finance... 

The good news is that there are ways to overcome these biases. By understanding your own psychological makeup, you can avoid falling prey to these mistakes. Here are some tips on how to do it:

1. Know yourself

What motivates you? What makes you angry? What scares you? How does stress affect your mood? These questions help identify your personal quirks. Once you understand why you act the way you do, you can take steps to change those behaviors.

2. Recognize your biases

Overconfidence bias is just one example of cognitive biases. Other common ones include anchoring bias, confirmation bias, availability heuristic, hindsight bias, etc. Understanding your own biases helps you recognize them in others. For instance, if someone tells you something is true, you'll probably believe him because you're biased toward believing people. If you hear about a stock that's performing well, you might buy it because you've been conditioned to think that it always goes up.

3. Think rationally

Pillar Four: The Business of Investing

Investing is about making money long term, not just trying to outsmart the market. There are lots of ways to do it, and many people make a living doing what they love. But there are some things you can learn that will help you become better at investing. This pillar covers those things.

The first thing you need to know is that the goal isn’t beating the market; the goal is making money over time. If you want to beat the market, you need to find something else to invest in.

You shouldn’t follow the financial press because they don’t tell you anything useful. They report on what happens in the markets, which is important, but they often miss the big picture. When they talk about stocks, bonds, currencies, commodities, and ETFs, they tend to focus on the short-term movements of prices.

The investment industry loves this... It sucks investors into the markets by exploiting human nature. The brokerage industry gets more brokerage fees (or now likely more data so their large clients can front run your trades). 

If you want to understand how the economy works, you need to look beyond the headlines. To really understand what’s happening, you need to dig into the numbers.

When you start looking at the data, you realize that the financial press doesn’t give you much information. Most of what they say is wrong.

Conclusion

And there you have it, the four pillars of investing. This is great information for the beginning investor. And if you want to follow traditional financial, you can make money over a long period of time. But your rate of return will be just average.

Best case scenario, you retire comfortably. Worst case scenario, the market crashes right before you want to retire and you end up working longer. That's the risk you take following this traditional expense.

We strive to avoid that risk here at barbellalpha.com ... Our barbell portfolio approach is mostly in low-risk investments. Investments that don't go down much, if at all... The we shoot for the stars with the edges of our portfolio. Here we'll buy investments with the potential to go up well over 10x and learn low risk trading strategies that can yield market beating returns.

Keep reading to learn more about these strategies as we navigate the markets together. 

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