Wednesday, March 10, 2010

The Investor’s Manifesto

William J. Bernstein doesn’t mince words in his book The Investor’s Manifesto: Preparing for Prosperity, Armageddon, and everything in Between. The style is very direct which makes it easy to read and understand. Bernstein has strong opinions about investing and he makes sense.

The main focus of the book is how to save and invest in preparation for retirement. Bernstein has tough love for the majority of individual investors who make serious mistakes that cost money, and has harsh words for the financial industry that takes advantage of people. The main advice is to find the right balance of low-cost index funds, and he gives a number of example portfolios. He also has some detailed advice on how to teach children to manage money well.

Here are a few parts of the book that caught my eye:

The Masses

“I have come to the sad conclusion that only a tiny minority [of investors] will ever succeed in managing their money even tolerably well.” I would add that this is true even with the help of a typical financial advisor. Bernstein believes that the two biggest problems are overconfidence and overemphasis on recent history.

The Investment Industry

“Be wary of the investment industry. People do not seek employment in investment banks, brokerage houses, and mutual fund companies with the same motivations as those who choose to work in fire departments or elementary schools. ... If rigorous precautions are not taken, the financial services industry will strip investors of their wealth faster than they can say ‘Bernie Madoff.’”

“If you act on the assumption that every broker, insurance salesman, mutual fund salesperson, and financial advisor you encounter is a hardened criminal, you will do just fine.”

Gordon Equation

Bernstein claims that the best estimator for real returns in the stock market is the Gordon equation which just adds the dividend rate to the real rate of increase of dividends. This certainly makes sense because it is essentially measuring business performance.

Renting vs. Buying a House

Bernstein’s rule of thumb is that if a house costs more than 150 times what it would cost to rent it monthly, you’re better off renting. “I have found that this is one of the fastest ways known to man of darkening a realtor’s face.”

Active Management

A table of costs of actively-managed mutual funds including expense ratio, commissions, bid/ask spread, and impact costs, gives totals of 2.2% for large cap funds, 4.1% for small cap funds, and 9.0% for emerging markets. Among “active mutual fund managers ... few can surmount these hurdles in the long run.”


Bernstein believes that commodities are just the “asset class du jour” and that future returns will be “certainly much lower than they have been in the past.”


“Nothing is more likely to make you poor than your emotions; nothing is more likely to save your finances than learning how to use cool, dispassionate reason to hold these emotions in check.”


Rebalancing in really bad years “will mean pouring large amounts into falling equities, when your friends and family are running around like decapitated poultry.”

Bernstein recommends periodic rebalancing and doesn’t like threshold rebalancing. His main reason seems to be that it can lead to frequent trading when markets are volatile. This doesn’t make sense to me. If the thresholds are wide enough, then when high volatility leads to trading, you are making lots of money selling high and buying low. Trading costs are easy to take when the trades are profitable, which they must be when using threshold rebalancing with sufficiently wide thresholds.

Mutual Fund Companies

“Do not invest with any mutual fund family that is owned by a publicly traded parent company.” Bernstein says that the profit imperative of publicly traded companies will drive them to fleece investors.

Spending Rate in Retirement

Bernstein’s advice on what percentage of your starting portfolio (adjusted for inflation) you can spend each year is more conservative than most:

2%: secure as possible
3%: probably safe
4%: taking risks
5%: you had better like cat food

Of course, these percentages depend on how you invest. The percentages are much different for a low-cost investor compared to another investor who pays 2.5% MERs.


Bernstein is clearly very smart and his analysis and advice is usually spot on. Any investor who chooses to stray from Bernstein’s advice should think carefully about exactly why his advice doesn’t apply. I definitely recommend this book to investors.


  1. Of course, the Gordon equation doesn't work too well for Berkshire Hathaway.

    I wholeheartedly agree with avoiding actively-managed funds operated by a publicly traded company. In fact I've been seriously considering withdrawing all my money from publicly traded banks and moving it into a credit union for the same reason.

  2. Patrick: That's a good point about Berkshire. Maybe you need to look at growth in see-through earnings.

  3. What is he referring to when he talks about impact costs? A quick google search leads me to guess it's the cost of establishing a sizable position.

    For example, if you wanted to buy 10,000 shares, and there were only 1,000 available at the current ask, you may have to pay higher asks for the remaining 9,000 shares, which would impact your buy price negatively. Thus, markets/stocks with lower liquidity are more expensive to buy.

    Is this what he's talking about?

  4. Gene: Yes, that is what "impact costs" means. I tend to think of it as the spread being wider for larger trades, but most people seem to separate impact costs from spreads.

  5. It's a valid point that impact costs are important. I occasionally get frustrated by a lack of available bids when building or selling a position, so I could see it being more frustrating for a fund manager. I suppose they must have dedicated traders who establish positions patiently.

    It also makes sense that small-cap stocks and smaller exchanges have higher impact costs. I can see that when I buy smaller stocks versus a blue chip like Intel. The spread on Intel will be one penny, whereas some small stocks may have a spread of one percent or more.

    Thanks for the review of the book. You highlighted a lot of interesting points.

  6. Patrick: regular banking is a bit different from mutual funds - in mutual funds it's impossible to know future returns and there's always an excuse for underperformance, so marketing drives a lot of sales. In banking you are often contractually agreeing to what you will get or in the case of short-term interest rates on an account you can move quickly if it changes without putting yourself at risk.

    Because of that I think that for-profit institutions are probably more motivated to find and provide something good as long as it still leaves them a reasonable profit. What credit union will give you 2% interest on your savings, or index funds with 0.33% MERs or less? If you're into the ETFs those don't come from credit unions either.

    Funnily enough I've started to think that credit unions around here are a marketing machine just like mutual funds.