5 Lessons From Bill Bernstein

Taking the Long Road
Financial writer Bill Bernstein has published a pamphlet on the basics of successful long-term investing entitled If You Can: How Millennials Can Get Rich Slowly. As The New York Times reviewed the booklet on May 3, this column isn't exactly a scoop. Then again, as Bernstein freely admits, the pamphlet guards no secrets. Rather, it dispenses principles that benefit from repetition.

Lesson #1: Save, Save, Save
Even if you can invest like Warren Buffett, if you can't save, you'll die poor.
Bernstein recommends that investors put away "at least" 15% of salary throughout their working lives. That differs sharply from the advice cited in this column last week. When planning for retirement income, last week's authors Gaobo Pang and Sylvester J. Schieber advocate a lifecycle savings approach that smooths consumption over time. Under their model, workers invest minimally at the beginning of their working years while repaying student loans and other debt, moderately during the child-rearing years, and then heavily in the final 10 to 15 years before retirement.

Bernstein, on the other hand, is old school. No smoothing for him. People who believe that they can't save the requisite 15%, he writes, are people who "spend too much money." Cut back today so that you can have more tomorrow. Nobody needs the latest smartphone, 900 television channels, or the daily latte. "Life without these [luxury items] may seem spartan, but it doesn't compare to being old and poor, which is where you're headed if you can't save." Better yet, don't live alone; find a roommate.

There's more to be written on this debate--and will be in tomorrow's column. For the moment, I'll say that Bernstein nudges in the right direction. As I learned when working on retirement-advice software, many employees believe that they can invest their way to retirement, by overcoming inadequate savings with terrific investment results. Expecting alpha is a lot easier than socking away cash. That is living a dream--and Bernstein correctly delivers the wake-up call.

Lesson #2: Know What You Own
Finance isn't rocket science, but you'd better understand it clearly.
This claim I dispute. The 401(k) industry has demonstrated the power of ignorance. Among this past decade's most successful mutual fund owners have been the most clueless--those who defaulted into target-date funds in their 401(k) plans. As a group, they rode out the 2008 bear market with remarkably few redemptions while still contributing, putting themselves in position to recoup all their losses and then some during the next five years.

Certainly there are investors who are too curious by nature to accept the blessing of ignorance, for example Bernstein himself. Those people do indeed require Bernstein's medicine, which, happily, needs no sugar. (This section of the pamphlet spends three wonderfully clear pages on the investment basics.) Also, this bliss comes with an expiration date. It's one thing to put money away and forget about it at age 25; it's quite another to do so when approaching retirement. The older investor will very much need to follow Bernstein's advice.

As with the first section, millennials would certainly benefit from listening to Bernstein. As with the first section, I doubt that many will. Their parents, however, are another story. Bernstein reports that The New York Times story was widely emailed, which is unsurprising. Those who are old enough to have accumulated assets, and to begin thinking seriously about what to do with them, are ready to hear Bernstein's message.

Lesson #3: Learn Market History
Those who ignore financial history are condemned to repeat it.
Bernstein continues, "There is no greater cause of mischief to the small investor than the confusion between the health of the economy and stock returns. It's natural for people to assume that when the economy is in good shape, future stock returns will be high, and vice versa. The exact opposite is in fact true: Market history shows that when there's economic blue sky, future returns are low, and when the economy is on the skids, future returns are high."

There is also the related paradox that the more enthusiastic people are about stocks, the worse that stocks tend to perform. Bernstein relates the story of Joseph Kennedy Sr., who claimed to have exited the stock market when the shoeshine boys started giving him stock tips. Conversely, BusinessWeek's famed The Death of Equities cover was printed three years before the beginning of a 30-year bull market.

This, I would argue, is suitable viewing for all. Whereas the fundamentals of expected returns can wait, understanding market psychology cannot. As with Odysseus' crew when near the sirens, novice investors fare best when wax is stuffed in their ears. The sooner that investors learn to ignore what they hear, and just let the portfolio run its course, the better off they will be.

Lesson #4: Just Say No
We have met the enemy, and he is us.
Or, more colorfully, "Human nature turns out to be a virtual petri dish of financially pathologic behavior."

This is the booklet's behavioral-economics section, carrying warnings about how people instinctively crave for action; see patterns that do not exist; are "comically" overconfident (although, echoing my wife, Bernstein says that this problem afflicts men more than it does women); falsely extrapolate lessons from the recent past; and perceive sense in technical analysis where only nonsense exists. If the wisest man is the man who knows that he does not know, then it follows that the wisest trader is the trader who does not trade.

As with the knowledge of market history, a basic understanding of behavioral issues will help investors from self-inflicted wounds.

This, too, strikes me as appropriate material for all ages. Learning how to avoid errors in decision-making is a lifetime skill and applicable to far more topics than merely investing.

Lesson #5: Hold That Wallet!
The financial-services industry wants to make you poor and stupid.
Wait now, Mr. Bernstein, are you not a financial advisor, and do you not put your clients into investments than are managed by a financial-services firm (DFA)?

Well yes he is, and yes he does. But Bernstein didn't mean those members of the financial-services industry. Nor, surely, did he intend the financial advisors who read this column. The distinctly above-average can breathe a sigh of relief.

The rest of the industry he beats with a large, metal-studded stick. Bernstein writes, "It's sad but true: By the time you've completed the reading for the previous four hurdles, you'll know more about finance than the average stock broker or financial advisor. ... In fact, the prudent investor treats almost the entirety of the financial industry landscape as an urban-combat zone. Most mutual fund companies spew more toxic waste into the investment environment than a Third World refinery."

One can argue with the severity of the message, but not its conclusion: keep costs low. Wall Street encourages investors to spend more. The savvy investor will realize that most of those arguments are wrong and will accept higher costs only rarely and reluctantly. With investing, less is more.

Tomorrow is a day for the critics. Bernstein disputes the usefulness of Pang and Schieber's consumption-smooth model, and he thinks the retirement situation is more serious than I portrayed in last week's column. Also, Eric Nelson, the advisor and blogger who was befuddled by Jack Bogle in Tuesday's column, defends his position. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.