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The portfolio doctor

William Bernstein in a park near his Portland, Ore., home. (Ricardo Nagaoka)

William Bernstein

PORTLAND, OREGON | Bernstein didn’t get into investing as a way to strike it rich. He was already a clinical neurologist when he decided to research the best way to invest his own money. In the couple of decades since then, the former physician has distilled his findings into books (including The Four Pillars of Investing and The Investor’s Manifesto) that translate advanced financial theory into practical prescriptions for ordinary people. Part of Dr. Bernstein’s charm lies in his bedside manner—he is blunt and funny, especially about what he calls “the rapacity of the investment industry.” Consumers should be on guard against Wall Street, he says. Main Street’s best defence is more knowledge—especially precise, scientific knowledge of how markets work now and how they’ve performed in the past.

Whatever prompted you to move from medicine to finance?

It all starts with the fact that I live in a country without a functioning social welfare system. You have to save, and save vigorously, for your own retirement. I decided I had to learn more about finance and investing. I approached the problem the way I thought anyone with scientific training would. I examined the peer-reviewed literature. I read the basic texts. Then I built a few computer models and collected some data to test various approaches. And when I was done—this was around 1994—I realized I had something of value to other small investors.

You’ve often said that investors sabotage themselves. How so?

Our ancestors evolved on the savannahs of Africa. What enables survival there is a focus on short-term risks—the hiss of the snake, the flash of black and yellow stripes that signals a predator. We overreact to such signals, which is good if your planning horizon is a half-second. But it’s not great for the modern world, where your planning horizon may be 50 years or more. We sabotage ourselves all the time by overreacting to passing events.

One good defence is to learn a little about history and economics. For instance, people always get the relation between geopolitics and economics exactly reversed. Especially with equities, you’re being rewarded for bearing risk. When things look the worst—in the early 1930s, for example, or in 2009—that’s exactly when the future rewards for buying stocks tend to be highest.

What’s a simple, smart way to invest?

I’ve suggested several portfolios that people have glommed on to. The most common one is probably the no-brainer portfolio. From an American perspective, it’s one-quarter bonds, one-quarter European stocks, one-quarter U.S. small-cap stocks and one-quarter S&P 500. You invest in each area through a low-cost index fund, so it’s really simple for anyone to manage.

Bond yields have sunk to meagre levels. Doesn’t it make sense to reduce your exposure to them and load up on stocks instead?

No, it doesn’t. If you look at the expected real returns, stocks yield maybe 2%. Earnings and dividends are growing at a bit more than 1%, so that gives you an expected real return of around 3.5%. Meanwhile, the expected real return of bonds is essentially zero, so that’s a premium for stocks of about 3.5%—and that’s pretty much what the premium has always been. There’s no reason to change your allocation.

The key—and I really want to stress this—isn’t the exact mix of assets. It’s being able to stick with some reasonable allocation through thick and thin. If you can do that, chances are you’ll blow the doors off most professionals on Wall Street.

What type of returns should investors expect?

Stocks are probably going to produce real returns of about 3.5% a year. Bonds are probably going to produce zero in real terms. So, a typical balanced portfolio of stocks and bonds is likely to generate about 2% a year in real terms.

What investments interest you right now?

Non-U.S. value stocks are cheap. That is, large-cap, foreign-value stocks—banks, utilities, things like that. An indexed investor can easily access them through any of several foreign-value exchange-traded funds.

What’s your least favourite holding?

Probably small-cap U.S. stocks. And that’s because they have done so well lately. It’s time to rebalance away from them.

What is the best piece of investing advice you ever got?

Three quotes come to mind. The first is from financier Bernard Baruch: “Something that everyone knows isn’t worth knowing.” That applies to Fed policy, Brexit, anything that’s in the financial press day after day. It’s already going to be reflected in prices.

The next one comes from the great investor John Templeton. “The four most expensive words in the English language are, This time it’s different.”

The last is also from Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

What hobbies do you have?

I love rehabilitating old computers—reformatting old hard drives and installing new operating systems. It’s a weird hobby, but I enjoy it immensely.

The 7th annual Invest Like a Legend issue This year, we talked to the granddaddy of index investing, John Bogle, about why you should dump your Canadian mutual funds, and personal finance guru Suze Orman about buying Tesla stock. Jim Rogers explains why he’s shorting the U.S. market, and William Bernstein makes the case for embracing 2% returns. Plus bond king Jeffrey Gundlach on why President Trump will be bad for markets.
Read the issue

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