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I RECENTLY FINISHED reading the second edition of William Bernstein’s The Four Pillars of Investing—twice. 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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“20 or 25 years,” in safe assets then “increased with the inflation rate” is ridiculous. When an author has to critique the 4% rule, he may have run out of things to write about. If you need to read a book by a Bernstein, read Against the Gods, by Peter L. Bernstein.
Thank you for taking the time to write this. This book has been on my reading list, and I’m moving it to the top. Many thanks to other readers for book recommendations listed in the comments.
The theory that SS income is “guaranteed” will be tested in 10 years or less.
Yep, death and taxes, not social security
Nice article Philip. I’m in the process of reading the new edition (for the 1st time) and look forward to his wisdom.
Rick, I felt the price of the book was an investment rather than a cost. I’m certain you’ll agree.
He suggests 25x in fixed to cover expenses in retirement
Way too much in bonds
3-5yrs is ideal
Another great read-Simple Wealth by Murray. it will change your philosophy
I fully agree that this is a great book. I am also reading it twice! Another terrific book that I’ve now read several times is William Green’s “Richer, Wiser, Happier.”
Enjoyed the article very much. Your takeaway #2 is something I tend to struggle with as it relates to the part about expenses above and beyond being covered by guaranteed income. My wife is a little older than me and has been retired for about 5 years now. She receives a pension and SS. In 2 years I hope to retire and will receive a small pension. These 3 sources of income will just about cover all of our expenses (fixed and discretionary) projected out starting 1-1-2026. Just to give us some additional room, I assumed her SS is cut by 25% in 2026. If hers is not cut, it would just give us more cushion to the upside. The bulk of my savings is in a 401k and while I would like to wait until later (because I’m a saver, not a spender), I will start taking distributions in 2+ years when I’m about 65. We have some things we want to do and don’t want to put off any longer than necessary. I have always heavily weighted my allocation to equities in my 401k and it’s at about 87% right now. I feel I can safely generate about $2000/month from my 401k at the time I retire. My wife will have to have start taking mandatory distributions from her 401k in 2026 at age 72. When I reach my FRA for SS in 2028, I reduced my benefit by 25% just for planning purposes. Mine might more likely be reduced – I just don’t know. It seems the standard recommendation is to substantially reduce your equity exposure as you get near or are in retirement, but maybe I can reduce it a little less than I think and still be able to weather the ups and downs of the market.
I think Bernstein’s point in item #2 is that its okay to have a healthy allocation to equities as long as you have a bucket of safe assets available so you’ll be able to meet your residual or unexpected expenses (like a doctor bill or home/auto repair bill) without selling stocks during a bear market to raise cash.
I’m at an age where I’m required to take Required Minimum Distributions from my IRA. When I take my RMD, I put some of the funds in safe assets in my taxable account, so I have enough liquidity to handle the curve balls that life throws at you regardless of the state of the stock market.
I appreciate your comments and how you handle your own situation. I’ve heard Dick Quinn mention that even at his age or stage of retirement, he still puts money into a savings or rainy day account. The total expenses in my spreadsheet also includes a monthly amount designated as savings just for those curveballs you mentioned.
Excellent article. But I would “quibble” with one point (unrelated? to finance):
“Yet only in finance is knowledge cyclical. It seems that each generation must relearn the investing principles that earlier generations have figured out.”
It seems to me that another area of knowledge is cyclical: war. I have noticed that war seems to be cyclical by generation. A generation that has experienced realizes how awful it is. Not so much the next generation. Until it happens to them. And so on.
I’m about 2/3 through Four Pillars 2nd ed at this point.
You could argue that amnesia (wishful thinking is the other side of the coin, not to make a pun) is active in every area of knowledge to some degree – because we’re human.
I’d love to ask the truly brilliant Bernstein himself about this. I recommend his “Delusions of Crowds,” too. There, he covers all the financial manias in similar but greater detail, along with coverage of many well-known religious group-based delusions.
Speaking of war, I’m not sure amnesia has much to do with the unspeakable and globally dangerous wars taking place currently, but other sorts of delusions certainly do…
I agree with your comments concerning the second edition of Bernstein’s book. Not only did he completely revise the book and update tables and charts with twenty years worth of more data, he described how and why his thinking about investing has changed since the first edition was published. I gave several copies to family members and friends!
I thought his book was exceptional. One lesson: for most, forget about finding the next hot stock and go with index funds.