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A Profitable Read

Philip Stein

I RECENTLY FINISHED reading the second edition of William Bernstein’s The Four Pillars of Investingtwice. This new edition is a significant rewrite of the first edition that was published in 2002. Even if you’ve read the first edition, reading the second edition is worth your time.

Though I’ve read most of the books written by well-known investment luminaries familiar to HumbleDollar readers, there were still pearls of wisdom I gathered from this second edition. Here are six of my takeaways:

1. Meet Sylvia Bloom. Many HumbleDollar readers are likely familiar with the story of Ronald Read, a humble man from Vermont who worked at a service station and as a janitor. His periodic investments in blue-chip stocks over his working life enabled him to amass a seven-figure portfolio despite his blue-collar income.

Bernstein—an occasional HumbleDollar contributor—introduces us to Sylvia Bloom, a legal secretary from New York who, like Read, invested in stocks over her working life. She also amassed a seven-figure portfolio.

I’m inspired by stories like these that show how folks of modest means can build significant wealth during their lifetime through patience and perseverance, all the while ignoring the short-term volatility of the stock market.

Bernstein cites Charlie Munger, Warren Buffett’s business partner, who admonishes us to never do anything to interrupt compounding. Both Read and Bloom allowed compound growth to catapult them to millionaire status.

Some people may claim that dying with a multi-million-dollar portfolio means you never enjoyed the money during your lifetime. But neither Read nor Bloom cared about living more lavishly. Both made generous donations to their favorite charities in their wills. They were satisfied with their modest lifestyles. It was charitable intent that drove them.

2. Stay the course with safe assets. Bernstein argues that it’s important to structure a portfolio with sufficient safe assets so we’re able to withstand those difficult times when the stock market declines 30% or more. Indeed, this is one of the reasons he decided to write a second edition.

Bernstein suggests that retirees maintain at least 10 years’ worth of fixed living expenses in safe assets. According to the author, if you can afford it, 20 or 25 years would be even better.

He defines fixed expenses not as all expenses, but rather those residual expenses beyond what retirees can cover with their guaranteed income from Social Security and any pension. Over time, this allocation to safe assets should be increased with the inflation rate.

Safe assets to Bernstein mean those backed by the full faith and credit of the U.S. Treasury. These include Treasury bills, certificates of deposit in amounts below the FDIC limit, and a U.S. Treasury fund with a duration of less than two or three years. He feels this will give us the resolve to weather bear markets with equanimity.

Bernstein notes that corporate and municipal bonds, while they offer potentially higher yields than Treasurys, involve credit risk and are too volatile to serve as safe assets during a “flight to safety.” The author doesn’t consider short-term investment-grade bond funds to be safe assets.

3. Shallow risk versus deep risk. Bernstein defines shallow risk as the occasional bear market that eventually reverses itself. Deep risk is a permanent loss of capital from inflation, confiscation by government, devastation from war or revolution, or deflation associated with economic decline.

Inflation, by reducing purchasing power, is the most common cause of a permanent loss of capital in America. There are many examples in history of countries debasing their currencies and impoverishing their citizens. The most vivid examples are hyperinflations of the kind seen in Weimar Germany in the 1920s. America hasn’t experienced hyperinflation—yet.

Some may cite the Continental dollars of the U.S. revolutionary era as an example of American hyperinflation, when over-issuance made the currency almost worthless. But we weren’t a nation then, just a collection of 13 squabbling colonies bound by a feeble Articles of Confederation.

To combat inflation, Bernstein recommends owning short maturities for your nominal fixed-income investments, preferably less than five years. TIPS and Series I savings bonds are also recommended inflation-fighters. Stocks, representing a claim on real assets, tend to keep up with inflation in the long run. In short, we have the tools to combat the most common source of deep risk in America.

A deflation like the one experienced in the 1930s is unlikely today because the government is able to print money. During the Great Depression, the country was on the gold standard, and printing fiat money wasn’t possible.

4. Financial amnesia. Writer James Grant has observed that, in most areas of human achievement, progress is cumulative. Each generation adds knowledge to the foundation of knowledge inherited from earlier generations. Yet only in finance is knowledge cyclical. It seems that each generation must relearn the investing principles that earlier generations have figured out.

Bernstein points out that many financial bubbles are inflated primarily by younger people who have no memory of the previous crash. Consider the role of young adults in the recent meme stock craze and the growing popularity of options trading, powered by the notion that you only live once (YOLO) and by the fear of missing out (FOMO).

The infamous BusinessWeek article “The Death of Equities,” published in 1979, scoffed at older investors for buying stocks. The editors felt that oldsters were behind the times and weren’t aware that the stock market had changed.

These “old fogies” understood that share prices were so low that superior returns lay ahead. Indeed, the article preceded one of the longest-running bull markets in history. Any investor who bought into the BusinessWeek narrative missed out on huge gains.

5. Three percent is the new 4%. Bernstein notes that William Bengen’s 4% rule was developed using returns from 1926 to the 1990s. If future market returns aren’t as generous, a 4% withdrawal rate may be too optimistic—and 3% may be safer.

He believes that you’re probably in good financial shape using a withdrawal rate of 2% to 3.5%. Beyond that, the author warns, you might be in the red zone.

6. Don’t buy municipal or corporate bond ETFs. During turbulent markets, these exchange-traded funds (ETFs) can suffer a liquidity mismatch between the low trading volume of the underlying bonds and the high trading volume of the ETF. This mismatch can cause wide ETF bid-ask spreads that increase the cost of transactions and reduce your return.

These six takeaways don’t come close to covering the scope of the material in Bernstein’s second edition. In my opinion, it’s a must-read for folks looking to broaden their investment knowledge. With the holiday season approaching, if you have such a person on your Christmas list, this book would make an excellent gift.

Now retired, Philip Stein was a public health microbiologist and later a computer programmer in the aerospace industry. He maintains that he’s worked with bugs, in one form or another, his entire career. Phil and his wife Jeanne live in Las Vegas. Check out Phil’s previous articles.

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