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Investing: Bernstein’s ‘4 Pillars of Investing’ and How They Work to Increase Returns

Renowned financial advisor William Bernstein says that in order to build a successful portfolio and be successful in investing, one must master four pillars of investing.

If an investor can base their decisions on these four pillars of investing, they can make smart investment decisions that will lead to long-term success.

William J Bernstein is a neurologist and financial advisor and co-founder of Efficient Frontier Advisers, an investment management firm. He has done a lot to empower individual investors who want to take their financial success into their own hands.

He is the author of many successful books and has written several articles on financial and economic history. He also runs the website www.efficientfrontier.com, which publishes quarterly journals on asset allocation and portfolio theory.

His book The Four Pillars of Investing: Lessons for Building a Winning Portfolio is considered a true classic and is very popular with many investment legends.

In the book, Bernstein explains how investors without a financial advisor can build a solid portfolio by learning about the four pillars of investing:

  • The theory of investing
  • The story of investing
  • The psychology of investing
  • The business of investing.

Knowledge of investment theory

Bernstein says the most important lesson in investing is that risk and return go hand in hand. If investors want higher returns, they must expect higher losses. On the other hand. If investors want to avoid the risk of losing money, they must be prepared to forego higher return opportunities.

“You cannot achieve high investment returns without high risk. Safe investments lead to low returns, ”he says.

Bernstein believes that investors can reduce the risk of an investment by holding it for the long term because the longer they own a risky asset, the less likely they are to make a loss. He believes investors can diversify their portfolios by owning other assets to reduce risk.

The greatest risk of all is the lack of diversification, since in the end it depends on the performance of the entire portfolio. He believes investors should try to learn the art of mixing different asset classes into an effective mix that can help them invest successfully.

Bernstein says past performance is not a guarantee of future results, as mean reversion most of the time results in stocks with high returns in the past producing low returns in the future. He also believes that the reverse may also be true, that poorly performing investments can improve over time and produce reasonable returns.

Bernstein says investors shouldn’t think about timing the market as it could backfire and suffer losses. “The market is a lot smarter than I’ll ever be. There are millions of other investors far better equipped than I am, all looking for the financial fountain of youth. My chances of being the first to find it are not so good. If I can’t beat the market, the best I can do is get in as cheaply and efficiently as possible, ”he says.

According to Bernstein, there is no evidence or theories to suggest that professional asset managers can regularly pick successful stocks because the short-term returns of individual investments appear to be random.

In his opinion, an ideal portfolio is one that doesn’t attempt to select individual stocks, as a lot of research needs to be done to ensure that the stocks selected are actually generating good returns. This kind of intensive and thorough research is not for everyone.

Therefore, he believes that simply investing in index funds without figuring out which companies will do well can be a better strategy than picking individual stocks.

He believes the world’s knowledgeable investors are choosing index funds, also known as passively managed investments. “The most reliable way to get a satisfactory return on your investment is to use index funds,” he says.

He suggests investors mix overseas stocks, precious metals stocks, and value stocks in their portfolio because they do well when the broader stock market is struggling.

2. Understanding the investment history

Bernstein believes that investors have little knowledge of financial and investment history and how the previous investment legends dealt with market bubbles, booms and busts.

He believes that by looking at years of information about the financial markets, investors can learn valuable lessons that can tell them about the short- and long-term behavior of various financial assets.

According to Bernstein, irrational exuberance is a major hurdle investors face in the market as the markets sometimes become irrational and can overreact. Therefore, it is important to recognize these signs so that you do not lose money.

Bernstein believes that investors who are unaware of financial history are irretrievably handicapped, and therefore understanding financial history provides investors with an additional dimension of expertise.

“The most profitable thing we can learn from the history of booms and busts is that in times of great optimism, future returns will be lowest; When things look grim, future returns are the highest. Since risk and return are just different sides of the same coin, there is no other way, ”he says.

Bernstein says that by understanding the history of investing, investors can make more thoughtful, rational decisions, and this could also prevent, or at least mitigate, future market bubbles.

3. Know insights into the psychology of investing
According to Bernstein, herd instinct, overconfidence, timeliness, need for excitement, myopic loss aversion and other human errors lead investors to make investment mistakes.

He believes that just knowing the psychological component of investing can help avoid some of the mistakes investors make. He feels that the state of mind investors are in affects their decision-making. It is therefore important to understand behavioral finance in order to avoid the most common mistakes and to face your own erroneous investment behavior.

Bernstein believes investors are their own worst enemies. “You are your own worst enemy,” he says.

Diversification and indexing are the most reliable methods of achieving long-term investment success, but they are not very popular with investors. “If indexing works so well, why are so few investors using it? Because it’s boring. Many people believe that investing should be exciting. But that’s not the case, ”he says.

Bernstein offers a list of techniques for dealing with psychological pitfalls:

  • Realize that conventional wisdom is usually wrong. Do not engage in herd behavior that makes booms and busts worse.

  • Don’t get too confident. Don’t think you are smarter than the market.

  • Ignore the last 10 years. Recent performance has little bearing on the future of any particular stock or mutual fund.

  • Avoid “exciting” investments. You shouldn’t invest in entertainment. This is not a game of chance. You invest to protect and grow your client.

  • Don’t let short-term losses affect your long-term strategy. Too many people panic at the first sign of trouble.

  • Know that the overall performance of your investment portfolio is more important than any individual part. You have investments that are depreciating year after year. Diversification helps to reduce these losses.

4. Be aware of the investment business

Bernstein says brokerage fees, mutual fund expenses, and taxes are a huge drag on investors’ financial portfolios. Hence, smart investors should do their best to cut all three.

Investors should try to avoid mistakes that can cost them money, such as fees for topping up funds, which are mutual funds with higher expense ratios. He also said that traditional financial journalism tends to overdo popular mutual funds and brokerage houses to boost sales, which can mislead investors.

He believes the magazines and newspapers are sensationalist and investors in general are better off ignoring the financial media.

“You can only write so many articles that say, ‘buy the market, keep your costs down, and don’t get too fancy’ before it starts to get really old,” he says.

He believes that financial professionals don’t know much about market behavior, so it is important for investors to educate themselves and make their own decisions based on market performance.

“Ninety-nine percent of what you read and hear in the financial media is advertising disguised as journalism,” he says.

He also recommends investors read some of the classics like Common Sense on Mutual Funds by John Bogle, A Random Walk Down Wall Street by Burton Malkiel, Winning the Loser’s Game by Charles Ellis, and a few others that can make your investment journey a lot easier.

According to Bernstein, if you can put a little effort into building an investment portfolio with broad diversification and minimal cost, they can actually outperform most professionally managed accounts.

For him, great intelligence and good luck are by no means the essential characteristics of successful investors; Instead, it is discipline and perseverance to “stay the course” that can truly bring investors to fame and glory in their investment journey.

As Bernstein rightly puts it in his own words: “Investing is not a goal. It is an ongoing journey through 4 continents: theory, history, psychology, economy. ”

(Disclaimer: This article is based on William Bernstein’s book The Four Pillars of Investing: Lessons for Building a Winning Portfolio)

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