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“The Long View” by Mornginstar is an excellent podcast for DIY investors with a long-term perspective. Their recent episode Bill Bernstein: Revisiting ‘The Four Pillars of Investing’ had on Dr. Bernstein to help promote his newly-updated The Four Pillars of Investing, Second Edition*. I haven’t read the new edition yet, but the podcast alone was full of useful evidence and unique nuggets.

(* I found it amusing that Amazon was advertising a book titled “Learn Proven Day Trading Strategies” on the same page. What an oxymoron! I seriously worry about new investors finding the good stuff amongst all this noise.)

I recommend listening or reading the handy podcast transcript, but here are my top takeaways and highlights.

Don’t interrupt compounding. Have enough safe assets to make it through the next crisis, which will inevitably arrive sooner or later.

[…] yes, compounding is magic, but you have to observe Charlie Munger’s prime directive of compounding, which is never to interrupt it. So, you have to design your portfolio not with the normal 98% of the world and 90% of the time in mind. You have to design your portfolio with the worst 2% of the time in mind so that you don’t interrupt compounding, which basically translated into plain English means that you probably should have more safe assets than you think you should have. In other words, a suboptimal portfolio that you can execute is better than a stock-heavy optimal one that you cannot execute.

Why you may prefer to own Treasury bonds over Corporate bonds, even if the latter has a slightly higher average return.

[…] it’s not just that you have the risk of bad returns, it’s bad returns in bad times. And that’s the problem with corporate bonds, is when corporate bonds do poorly, they do poorly at the worst possible time.

[… the] 0.8% or 0.6% returns premium you get over Treasuries from high-grade corporate bonds just isn’t worth it.

Have realistic expectations if you tilt to factors like size, value, quality, and so forth.

I think that in finance, even the best bets you make are at best 60/40, most of the time they’re closer to 51/49. So, you just have to resign yourself to the fact that you’re going to be wrong a large part of the time in exchange for being right most of the time. And even then, the margin isn’t going to be that much.

How to protect your portfolio against inflation.

Well, for starters, you keep your bond duration short so that when rates rise, you can roll them over at the higher rate. And stocks, although stocks don’t do well initially with inflation, what you see is that over the very, very, long term, they do.

The hazards of backtesting. Whatever has performed well mostly recently will overwhelm the results.

What happened back in the 1970s and ‘80s and ‘90s is people fell in love with mean-variance optimization, the Markowitz algorithm. It looked like all you had to do was collect asset-class returns and standard deviations and the correlation grid, which is the inputs to the Markowitz algorithm. And you could predict the future-efficient frontier, that is the allocation that gave you the most amount of return for a given degree of risk or for a given degree of return that stopped you with the lowest degree of volatility. And it turns out that the inputs to that produce enormous changes in the outputs and that the algorithm, if you’re going to use historical returns, then favors the asset classes with the highest returns.

Why not 100% stocks for young folks?

There is a wonderful quote from Fred Schwed’s marvelous book, Where Are the Customers’ Yachts?

“There are certain things that cannot be adequately explained to a virgin, either by words or pictures, nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own. If you’re a young investor, you’re an investment virgin, you’ve never lost a real chunk of money, and you have no idea how you’re actually going to respond to stocks falling by 30% or 50%.”

Asset allocation for early retirees:

Someone who is a FIRE person—financial independence, retire early—and wants to retire at age 40, better have a fairly aggressive allocation with a very low burn rate.

Not a fan of lifetime income via annuities. First, they are greatly exposed to inflation risk. Second, they are exposed to credit risk (insurance company failure). He is skeptical about the state guaranty system.

These are all commercial products and people are very fond of pointing out, yes, these products have state guarantees, but of course, they’re funded by the insurance industry. There is nothing magic about a state guarantee. Most states have fairly low caps on the amount that is protected. And then, finally, even those guarantees can fail. And if you don’t think that that can happen, you should go Google “Executive Life Insurance.”

Dr. William Bernstein is continuing his press tour for the second edition of his classic investing book The Four Pillars of Investing, and I found myself listening/reading to another podcast from The Meb Faber Show: Bill Bernstein on Financial History, Star Managers & The 4 Pillars of Investing.

There was some overlap between his discussion points here and the Morningstar podcast, but it was definitely worth the time spent to get a few more interesting discoveries.

He owns zero individuals stocks. I’m pretty impressed by the discipline level of this. No vestigial stock shares from his youth, no sentimental holdings, not even a humblebrag holding. (“Well, I do have a few shares of Apple that I picked up during the IPO in 1980…”)

Meb Faber: Does Dr. Bernstein have a play account? Do you allow yourself to have some investments you’ll trade around a little bit or are you too strict for that?

Dr. Bernstein: No. For two reasons, number one is, I learned my lesson early on just like you did. And, number two, I also am a co-principal in an IRA firm, and I just don’t want to be dealing with trading individual stocks.

He thinks that safe withdrawal rates are improving.

I am reasonably optimistic, as optimistic as I’ve actually been in 15 or 20 years about securities returns in about people’s ability to spend. What we told people until relatively recently was if you’re a typical 65-year-old retiree, a 2% burn rate is bulletproof, 3% is probably safe, 4%, you’re probably taking some risk, and at 5% burn rate, you’re taking a real risk. And I think that given the increase in real bond rates and the general decrease in valuations almost everywhere in the world except in the U.S. and especially with U.S. large cap stocks, I think that expected returns have increased to the point that you can increase those burn rates by about a percent. And that may not sound like very much, but going from 2% to 3% gives you 50% more spending power each and every year. So, I’m reasonably optimistic about future security returns, both for people who are going to be putting money away, and people who are going to be spending as well, assuming they didn’t get too badly clobbered in 2022.

Adding in that additional percentage point would change the quote to “if you’re a typical 65-year-old retiree, a 3% burn rate is bulletproof, 4% is probably safe, 5%, you’re probably taking some risk, and at 6% burn rate, you’re taking a real risk.” That is a big change, as he says.

Author and investment advisor William Bernstein wrote a thoughtful WSJ piece on bonds, which I think is useful for the DIY investor. The overall theme is that you should take minimal risks with the bonds in your portfolio. Taken in isolation, some types of bonds are likely to provide higher long-term returns than others. However, you should consider how they fit into your entire portfolio. Historically, it has been more efficient to take your risk with stocks and use your bonds for their stability. Bonds become the “dry powder” you can use to buy more stocks after a crash (rebalance!).

I found myself breaking down the article into three main categories. The types of bonds he recommends most, the ones he considers acceptable, and the rest which should be avoided. These are my short notes; read the article for the supporting arguments.

PREFER

• Individual US Treasury bonds, manually laddered.
• US Treasury bond mutual funds, for smaller balances.
• Top-yielding FDIC-Insured Certificates of Deposit, manually laddered.
• Short-term or intermediate-term, higher-quality municipal-bond funds, for large taxable balances.

OKAY

• “Total bond index” mutual funds, as they consist mainly of high-grade, government-backed bonds.
• US Treasury bond mutual funds for larger balances.

AVOID

• All corporate bonds, but especially avoid lower-grade and/or longer-term corporate bonds.
• Lower-grade and/or longer-term municipal bonds.

I would point out that inflation-protected bonds (TIPs) are not mentioned directly, I guess because they aren’t directly comparable to these nominal bonds. Either that, or he just considered them to be the same as traditional Treasuries. He talks about TIPs a lot elsewhere (including his books), so a little specific advice would have been helpful.

My other opinion is that running your own bond ladder is quite doable but only the most DIY of DIY investors would do it better than a low-cost bond fund. I own individual TIPS and it’s not hard but not a ton of fun either to keep track of auction dates and avoid cash drag. Vanguard charges only 0.12% annually for their short-term government bond ETF (VGSH) and Admiral fund equivalent. $12 a year per $10,000. $120 a year for $100,000. I’d rather just pay that unless I had millions or I had a lot more free time. However, if you’re already paying a financial advisor, I would let them manage an individual bond ladder as part of their fee.