Portfolio Investing 101: Bill Bernstein

In his new book, The Investor’s Manifesto, William J. Bernstein makes a strong case not just for the idea of portfolio investing, but the fact of it. Any one of us, with a modest amount of effort, can build a good portfolio, Bernstein argues.  Then he proves it.

Bernstein is not your typical individual investor. A PhD and formerly practicing neurologist, he has a wild passion for investing, and an appetite for dot matrix diagrams that can be a bit intimidating.  A bestselling author of four previous books on investing and economic history, in this tome the good doctor set out to write something accessible to the masses. He’s achieved his goal.

Chapter 3 offers a practical blueprint for building a smart portfolio that’s logical and practical in equal doses.

Though simple, Bernstein argues even his most plain vanilla concoction will match or beat the overwhelming majority of professional investors in the decade to come. It’s well worth the short time investment to read Bernstein’s full explanation, but here is a taste of the steps he takes to build a diversified portfolio:

1. Allocate to bonds a portion of your portfolio equal to your age. If you are 30, put 30% in bonds. If 40, put 40%. (This presumes average risk tolerance, and should be adjusted according to your own temperament.)

Step 1

Let’s presume you are 40

Split your holdings int 60% equities, 40% bonds.

Step 2

Then take the 60% that’s in equities and split that into into foreign and US stocks. Again, the right balance depends on your outlook, but 70% US, 30% Foreign will work for a lot of people.

Simple Portfolio:

60% Equities –> 42% Total US Stock Market + 18% Total Foreign Market

40% Bonds

You could stop there, but it wouldn’t hurt to take

Step 3

Add a few more asset classes including REITs for Real Estate exposure (no more than 10%)  and split foreign into developed and emerging markets.

Simple Portfolio 2:

42% Total US Stock Market –> 39% Total US Stock Market + 3% REITs

18% Foreign Market –> 12% Foreign Developed Markets + 6% Emerging Markets

40% Bonds

For investors with enough money to spread across more asset classes ($250,000 plus), and a tolerance for complexity, Bernstein takes

Step 4

Further split out a set amount for “value” stocks and small company stocks for a pie of the following 12 slices:

Portfolio

39% Total US Market –> 10% US Large Market + 9% US Small Market + 10% US Large Value+ 10% US Small Value

3% REITs

12% Foreign Developed Markets –> 3% Foreign Developed Large Market + 3% Foreign Developed Small Market + 3% Foreign Developed Large Value + 3% Foreign Developed Small Value

6% Emerging Markets –> 3% Emerging Markets Large Market + 3% Emerging Markets Large Value

40% Bonds

These are “most definitely not hard-and-fast recommendations”, Bernstein writes. But they do show that something that seems challenging to do, can be pretty simply broken out into steps that are easy to follow and understand.

In a later chapter of the book, Bernstein outlines a good number of specific low-cost mutual funds that can be used to build a portfolio. And though he’s skeptical about some aspects of Exchange Traded Funds, he even includes a few ETFs.

Bernstein starts his chapter on portfolios with a description of the fate of Japanese investors nearing retirement in 1989.  With all the recent speculation that the US may (or may not) be on the road to emulating Japan, his cautionary tale becomes all the more powerful.

Between 1969 and 1989 $1 invested in Japanese stocks rose to $57.23 in value. In the two decades since, $1 invested shrank to 60 cents.

The lesson Bernstein’s hoping to teach is that no one should put all their money in Japanese equities. Or US equities.

Or Treasury bonds. The average 65-year-old man today will live until almost 82, he notes. If he gets to 82,  he’s likely to live to 89. In fact 95 isn’t impossible with medicine improving as it has. But an all-Treasury retirement portfolio won’t get him further than about 12.5 years if he spends 5% of it a year and inflation averages 3%.

That is the best way to end up exactly where you don’t want to be: without enough savings over the long term.

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