Investing 1.01, don’t forget the basics. #80

I came across this book The four pillars of investing by William Bernstein by chance last year in June 2016. It’s interesting to note that he has an MD and a Ph.D. in Chemistry and that he began his career in neuroscience before deciding to become a financial investor and an author of historical books. So what made him change course? According to him in the first minutes of this podcast, it was the realization that he needed to learn to save and invest to better afford his way through education and life. Simple, and obvious. It’s interesting that so few people have the diligence to go through this learning process.

The content of this book was not new to me. Nevertheless, it was another useful reminder of some of the timeless and fundamental investing principles that the general public often misses.

Here are my main takeaways on the four pillars:

Pillar number 1: Investing is a probability game of risk vs. rewards.
“Do not expect high returns without risks.” But I would have added, learn to play only when the odds are in your favor. Which is essentially what he says when he comments that: “Good (growth) companies are generally bad stocks; bad (value) companies are generally good stocks.” Because indeed, value beats growth over the long run. “When the political and economic outlook is brightest, returns are lowest. It is when things look darkest, that future returns are the highest”.

Pillar number 2: History repeats itself.
“About once every generation, the markets go barking mad. If you are unprepared, you are sure to fail.” Booms and busts do happen because people gravitate towards lottery ticket and excitement. Bubbles have occurred throughout the market’s history (tulips, canals, railroads, the 1920s, the 1960s) and will continue. You are better off to buy what others do not want, i.e.: what’s boring. The basic rule of technology investing is that it is users, not makers, who profit the most. That echoes the saying of other mentors of value investing.

Pillar number 3: Use the market behavioral biases to your advantage.
Don’t fall for conventional wisdom. Don’t try to fight the last war. Don’t listen to stories, because great companies don’t necessarily make great investments. Don’t go for the glamorous. Don’t try to figure out patterns. Don’t check your portfolio’s value each day. Instead, you better focus on long-term fundamental data and value. Remember that the most exciting stocks have the lowest returns, and the most boring ones have the highest. Beware of your personal biases: “we tend to remember those activities, or areas of our portfolios, in which we succeeded and forget about those areas where we didn’t”. Bubbles occur whenever investors begin buying stocks simply because they have been going up. “Buying assets that everyone else has been running from takes more fortitude than most investors can manage. But if you are equal to the task, you will be rewarded”. So tune out the day to day financial noise. And focus on what, your analysis tells you, has attractive odds.

Pillar number 4: Don’t be naive, keep in mind wall street’s incentives.
“The stockbroker services his clients in the same way that Bonnie and Clyde serviced banks.” The modern financial services industry is designed solely to serve itself, not you. Stockbrokers’, journalists’, and mutual fund companies’ interests are opposed to yours. Keep your costs low and think independently.

On a side note, I liked that he highlighted value average investing as an improvement over dollar cost averaging. The tilt is that, if the funds decline in value, you must invest even more. If the funds go up in value, you must invest less. A simple tool that helps invest at market’s bottoms rather than tops. Since the market is mostly efficient, indexing with any such averaging strategy is likely to do better in the long run. But I would have argued with him that there are reasons to believe that there will always be structural pockets of inefficiencies in the small/mid-cap segment because it is too small to be scrutinized by all the large players.

Meanwhile, I recently came across this podcast below. I liked that when asked about life lessons around investing he answered somewhat the following: “Lesson 1: Start owning businesses early in your life. Lesson 2: Use money to buy time, not things.” I couldn’t agree more.

My purpose in life is independence, fulfillment and a better understanding of how the world works. Like Charlie Munger, I believe in the discipline of mastering the best that other people have ever figured out. And like Sir Isaac Newton, I believe in our ability to see further than any others before us by acknowledging that we are standing on the shoulders of giants. With this blog, I hope to keep track of my learning about investing, business, decision making, entrepreneurship, and self-development while inspiring others to do the same. For the moment the format of this blog will be one post for each book that has influenced me, but I expect it to evolve over time. This is book number 80 of the journey. Join me now. John.
One clap, two clap, three clap, forty?

By clapping more or less, you can signal to us which stories really stand out.