Friday, January 22, 2010

The Investor's Manifesto: Prudence Before Riches

The Investor's Manifesto: preparing for prosperity, Armageddon, and everything in between, by William Bernstein. Rating: 4/5.

A good description of basic investment strategy, written in a familiar, mildly humorous style. Bernstein's approach draws heavily on an investment version of Pascal's wager: Financial ruin in retirement if markets turn south is worse than living modestly (now and in retirement) even if markets are booming. Bernstein advocates for simple, unglamorous investing:
"The name of the game is not to get rich, but rather to avoid dying poor. In fact, if you follow the advice in this book, I can guarantee you that you will not get fabulously wealthy. Rather, I've striven to simultaneously maximize your chances of a comfortable retirement and minimize your chances of living out your final years in poverty. I know of no more laudable or more worthy investment goal." (183)

As a starting point, Bernstein cites the "age rule" for asset allocation: The percentage of bonds in your portfolio should be roughly the same as your age. This percentage should be increased or decreased up to 20 percentage points depending on your risk tolerance. Then, Bernstein recommends between 60-80% domestic stocks and 20-40% foreign stocks, and suggests that money should be placed in low-expense index or passively managed mutual funds. "Does this portfolio seem overly simplistic, even amateurish?" Bernstein asks---"Get over it. Over the next few decades, the overwhelming majority of all professional investors will not be able to beat it" (89). Investors interested in a more complex allocation could divide the stocks into small and large, value and market companies; but, Bernstein indicates that growth companies should be avoided, as they have a small dividend stream relative to stock price, and the dividend growth rate is a better predictor of future performance than growth of stock price.

Chapter 1, "A Brief History of Financial Time," gives an overview of the history of financial markets and lays down a number of important principles of how markets work that undergird Bernstein's investment philosophy. Chapter 2, "The Nature of the Beast," describes the core of the philosophy. Chapter 3, "The Nature of the Portfolio," applies Bernstein's philosophy to creation of a portfolio. Chapter 4, "The Enemy in the Mirror," presents a number of neuro-psychological effects and common mistakes that investors make that derail them from their investing goals. Chapter 5, "Muggers and Worse," warns against brokerage houses and the like. Chapter 6, "Building Your Portfolio," introduces dollar cost averaging and value averaging, and provides four example scenarios of prototypical investors. Finally, chapter 7, "The Nature of the Game," provides a summary of the principal lessons from the book, suitable for sticking to the refrigerator for frequent review.

The book is approachable for beginning investors, though some experience with investment vocabulary is helpful. Important points are placed in call-out boxes, and mathematical details are relegated to sidebars that can be skipped or skimmed without losing the overall message. Each chapter has a bullet-point summary of the most important topics for review.

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