Krenzel's Reviews > The Four Pillars of Investing

The Four Pillars of Investing by William J. Bernstein
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's review
May 22, 2008

it was amazing
bookshelves: finance

In the introduction to his book, "The Four Pillars of Investing: Lessons for Building a Winning Portfolio," Dr. William Bernstein states that the "competent investor never stops learning." Yet, because the world of investing can be such a confusing place, it sometimes seems that the more you learn, the more confused you get. As a participant on the Bogleheads message board, I feel I am an educated investor but still I often get lost after reading all the different debates: Should I invest in total markets or slice and dice my portfolio? Should I invest all my money at once or adopt a dollar cost averaging philosophy? How much foreign exposure should I have? Is now the right time to buy REITs, or do I need them at all? One day, while perusing the message board and sifting through some of these same questions, I found a suggested investing reading list, and this book was listed as the starting point. In this straightforward book, explained with easy-to-understand examples, Dr. Bernstein provides a solid framework for investors to begin to answer some of these questions.

In setting this framework, Dr. Bernstein introduces readers to four basic concepts, or what he terms the four pillars of investing: the theory, history, psychology, and business of investing. The first pillar, the theory of investing, gets most of his attention, as it comprises the first 100 pages of the book and explains how the bond and stock markets work. In this section, Dr. Bernstein emphasizes what he calls the "most important concept in finance" – the relationship between risk and reward. If investors want high returns, they must take great risks. Following this logic, Dr. Bernstein makes some conclusions that may seem foreign to most investors. For example, the best time to invest is not when things are going well, but when they are going poorly. Those who invest during a bubble are not taking a risk and therefore can expect low returns, whereas those investing during a bear market are taking a risk and therefore can expect (but will not be guaranteed) higher returns. Similarly, those who invest in "good companies" like Wal-Mart can expect lower returns than those who invest in "bad companies" like K-Mart, because good companies, with low risk, are generally bad stocks, while bad companies are generally good stocks. This idea – that high returns cannot be achieved without significant risk – is the key concept Dr. Bernstein continues to emphasize throughout the book.

While the first pillar gets the most attention, Dr. Bernstein terms the second pillar, the history of investing, as "the one that causes the most damage" to investors. What separates the professional investor from the amateur investor is that the professional recognizes that bear markets are a fact of life – they inevitably come about once every generation, usually sparked by a new technological advance. Professional investors stay the course and don’t panic; they have a plan and stick with it. In fact, for beginning investors, a bear market is a blessing, allowing them to accumulate stocks at low prices. This concept again ties to the relationship between risk and return: throughout history, in times of great optimism, when prices are the highest and the risk is the lowest, future returns are the lowest, and when times look the bleakest, and risk is the highest, future returns are also the highest.

In the third pillar, the psychology of investing, this relationship between risk and return is again raised. Most investors follow conventional wisdom of the time, investing in specific stocks or asset classes that are currently the most successful and thus buying at high prices. Dr. Bernstein provides two strategies to counter this psychology. He advises readers first to identify the conventional wisdom of the time and do the exact opposite. He also advises readers that assets with the highest future returns tend to be the ones that are currently most unpopular. The investor that is able to go against the flow – to stick with unpopular asset classes and pay attention to his or her entire portfolio return – in the long-run will be the most successful.

Finally, the fourth pillar concerns the business of investing, which details how brokers, analysts, and the media work together to make money at the expense of often ignorant investors by peddling bad or biased information. Instead of paying exorbitant fees to brokerage firms or financial advisors, which steer investors to underperforming managed funds, investors can buy low-expense index funds through companies like Vanguard and thus tap "into the most powerful intelligence in the world of finance" – the market itself, which is, according to Dr. Bernstein, the best advisor available.

Dr. Bernstein concludes his book by applying lessons learned from these four pillars and giving readers practical advice for how to construct their own portfolios. Although this section fell short of answering all my questions, the book as a whole serves as an essential investing guide in providing investors with a basic framework to use in evaluating the myriad of investing choices available. As even Dr. Bernstein concedes, "Four Pillars of Investing" is not an all-encompassing book on investing. It is not the only book you will need to read, and it is probably not the first investing book you should read, but it is nonetheless a book every investor should read.
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Reading Progress

May 22, 2008 – Shelved
Started Reading
June 11, 2008 – Finished Reading
July 11, 2008 – Shelved as: finance

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