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Book Summary: "The Investor's Manifesto" by William Bernstein

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Drawing on the financial crisis of 2008, Bernstein writes a story for the investors of today in The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between. Those who learnt from the 2008 financial meltdown know that they need to monitor their investments more diligently and resist the temptation to leave all to ‘the bankers of Wall Street’. Bernstein examines a brief history of the markets, examines aspects of portfolio management and provides a convincing argument for index (or tracker) funds.

The Investor’s Manifesto is divided as follows:

  1. A Brief History of Financial Time
  2. The Nature of the Beast
  3. The Nature of the Portfolio
  4. The Enemy in the Mirror
  5. Muggers and Worse
  6. Building Your Portfolio
  7. The Name of the Game

Like many authors before him, Bernstein ends the book with a lengthy list of further reading recommendations.

A Brief History of Financial Time

Bernstein discusses the history of finance, that is to say, the story of risk and return, debt and credit. Before money, cattle served as capital that could be loaned by creditors and borrowed by debtors. The ancient farmer would borrow a head of cattle one season and repay it twice over the next. The return on investment was 100%. A rate that hardly any investor can fathom achieving in the current climate. At the time, this high rate was driven by supply and demand. The price was also driven up because all loans were considered risky – there was a significant probability of default (failure to repay the debt). Especially considering that a default in this situation meant that the creditor could seize all of the debtor’s property. This meant that these loans were highly protected for creditors and therefore capital was in good supply.

Over time, the amount of capital increased and as it did so, interest rates fell. Bernstein argues that by sharing this he can help readers understand the nuts and bolts of being an investor and help readers recognise that they’re in the same game of risk and reward.

He translates this into those investors who own stock. With stocks, generally, your risk is higher as when a company goes bust or bankrupt, the last in line to receive a payoff is the stockholder. This is why, as a stockholder, you deserve a higher return, on average, than bond holders who get their money back first.

The increased possibility of losing your entire capital invested, difficulty of estimating future profits and the residual nature of equity ownership means all equity owners deserve a substantial return (referred to as “equity risk premium”).

After examining a different historical case study (Venice in the fifth centry A.D.) Bernstein concludes that markets do not always recover. Taking the shut down of the St. Petersburg exchange in 1914 (because of World War I) as an example, the Russian stock and bond markets were among the world’s most respected and active. They never reopened.

He does suggest, though, that following the 2008 crisis, we will recover and once more investors will be provided with returns. A pattern from history that we as investors should remember is that during times of great social, political and military turbulence, the prices of both stocks and bonds usually decline. This often sets the stage for high future returns. There is no guarantee that this will happen, though.


The Nature of the Beast

**If you’re not prepared to bear risk and incur losses in your portfolio then you can guarantee low returns. Diversification (holding stocks, bonds, cash and more) in your portfolio is a good way to help balance risk but this only works well over years and decades. If you’re looking at weeks and months then you’ll see poor returns.

Bernstein explains that wise investors realise that long-term returns are the only ones that matter. He uses a strong example of showing how an investor who can earn 8% annualized return will multiply their wealth tenfold over the course of 30 years.

Bernstein clearly articulates that although we can use history to understand how markets decline and rise, as an investor you cannot look to history to estimate future returns. Importantly, even if you see other investors trying to do this do not feel tempted to do the same – this is a mistake.

Some brokers can provide an expected return but this is always presented as positive, otherwise no one would invest. Proceed with caution.

Always think about your real returns by working out your returns after inflation. Estimating future returns should be worked out using interest and dividend payouts and their growth/failure rates.

Expected Return = Dividend Yield + Dividend Growth Rate

The rule of 72 can help investors approximate the doubling time of any investment. Divide your 72 by your rate of return and that will give you a good estimate for how many years it will take to double your capital e.g. 72/10 = 7.2. It will take 7.2 years for your money to double if you can earn an annualised return of 10%.

Home ownership is not an investment but a consumption item. History is a good tool for understanding risk but not good for estimating future returns.

Investors should design their portfolios to minimise the chances of dying poor. Maximise your returns by minimising your expenses (don’t try to pick stocks or use fund managers).

The Nature of the Portfolio

**Unless you diversify, you risk suffering the fate of post-1989 Japanese investors. Before worrying about your asset allocation, Bernstein forces the reader to understand four things:

  1. Save as much as you can

  2. Have an emergency fund

  3. Diversify widely

  4. Use passive/index funds

When considering your asset allocation be sure to include a combination of asset classes that move in different directions at least some of the time. To start, Bernstein advises using the age = bond allocation rule of thumb.Buy stocks when the economic clouds are the blackest, and sell when the sky is the bluest.

Complex allocations are suitable only for larger portfolios. (as there are often fund minimum requirements)


The Enemy in the Mirror

Your own emotions and how you respond to them can make you poor when making investment decisions. Our emotions make us who we are as humans but being humans we also crave easy-to-understand narratives. In finance, this is bad for our portfolios.Learn to automatically mistrust narrative explanations of complex economic or financial events.

Choosing “exciting” investments that we don’t 100% understand may sound glamourous and can be tempting as we search for entertainment. This should be avoided in your investment portfolio.

There’s also an ego in all of us that believes we are better than average. You are not as good looking, as charming or as good a driver as you think you are. The same goes for your investing abilities. The smartest trading strategy is not to trade at all.

Keeping up with the Joneses can also lead to common mistakes. We may feel encouraged to be as risky as our neighbours, and we may feel left out if we’re not invested in the next “hot stock”. Steer clear!

Your best action is to understand how to bear risk and loss.

Regularly rebalance your portfolio as this forces you to move in a direction opposite that of the crowd. Emotional discipline is key.

Muggers and Worse

Unlike your doctor, lawyer or accountant, your broker is not a fiduciary: that is, he is under no legal obligation to place your interests above his own. This is Bernstein’s central argument and he goes on to discuss why funds are better suited to investors.

  • Wide diversification
  • Transparency of expenses
  • Professional management
  • Protection
  • Ease of execution

However, since mutual fund company revenues flow proportionately from assets under management (AUM), they focus primarily on growing the size of their funds, and not on your returns.

* Building Your Portfolio*

Bernstein opens with a question to the reader: How much money will you need in retirement?

He offers two tips:

  1. Save as much as you can, start as early as possible and do not ever stop.
  2. Consider an immediate fixed annuity in retirement.

Each dollar that you do not save at 25 will mean two inflation-adjusted dollars that you will need to save if you start at age 35, four if you begin at 45, and eight if you start at 55.

Bernstein explains that some experts suggest that over-saving risks “under-consuming” (depriving yourself) during an investor’s prime years but the consequences of under-saving and living in poverty as a pensioner are far more adverse.

Bernstein uses four example investors and how their portfolios might be built based on their current situation.

Unsurprisingly, Bernstein is more concerned with passing on money intelligence to heirs rather than assets. Providing your heirs with the ability to save, spend and invest prudently is the best inheritance.


The Name of the Game

If you commit to reading just one chapter of Bernstein’s manifesto, you should read Chapter Seven – The Name of the Game where he summarises the key ideas in the book.

His sign-off paragraph states clearly that the name of the game is not to get rich, but rather to avoid dying poor.

Evaluation

Bernstein presents a compelling case for simplicity: keep your portfolio well-diversified, rebalance, save for retirement as early as possible and keep all portfolio-related expenses as low as you can. There are some unique references in the “A Brief History of Financial Time” chapter that provide a very engaging backdrop to the entire manifesto. This is a worthwhile read no matter what your thoughts are on investing.