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

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

What's truly scandalous is most finance professionals are unaware of the scientific basis of investing, which consists of four broad areas. The four areas are as follows: the theory, the history, the psychology, and the business of investing.

The theory section of the book focuses on the concept of risk and returns. Assets with higher returns involve higher risks. Assets with lower returns involve lower risk. Financial history provides us with wisdom about the nature of capital markets and returns on securities. Smart investors ignore the history of investing at their peril. Next you have the DDM or discounted dividend model which allows the investor to estimate returns of stocks and bond more accurately than the study of historical returns. The value of a stock or bond is the present value of its future income stream. The value of a future income must be reduced to reflect its true present value. This reduction must take into account four things: the number of years you have to wait, the rate of inflation, preferences for present consumption over future comsumption, and risk itself.

The history section of investing lifts up the engine of stock returns as the rate of technological progress. Technological innovations comes in intense spurts. Economic and investment occur evenly which means the flow of capital to new technologies is not driven by the demand from the innovators but from the impressionable investing public. Put another way, the process of transformative inventions bring long term progress and prosperity to society on the whole, short run profits to the early lucky few investors and ruin to all later investors.

The psychology of investing focuses on our own behaviors having a negative impact on our financial decisions. This means we focus on the wrong type of risk, and short term verus long term gains. We look for patterns where there are no patterns in the pricing of stocks and bond.

The business of investing is basically, buyer beware when dealing with the brokerage industry. For example, the most basic data pertaining to broker backgrounds, performance, portfolio turnover and expenses does not exist. The goal of the stock broker is to transfer your wealth to themselves. You can not trust your broker.

With the mutual fund business you have a better “chance” of emerging intact with your dealings. Watch out for the load funds. The fees for this fund reduce your return to .48 per year. This is less than the no load funds returns. Major no load companies are Fidelity, Vanguard, Janus, T. Rowe Price, American Century and Invesco, according to the author.

Variable annuities like the load funds possess high sales fees and insurance charges. Do not buy them for your tax deferred accounts.

In chapter 12 the author offers these suggestions: You will never be completely certain your retirement will be a financial success. You are faced with the trade off between the amount of your savings you spend each year and the probability of success. So the less you spend the better off you will be. Do not withdraw more than 5 percent from your nest egg amount in any given year..

The short version to retiring early is to save a lot, start early and spend as little as possible. The book is worth the time I took to read it. The introduction, chapters 12-15, and the bibliography sections of the book give you a foundation to build upon. Read them first. Good Reading.