Search Results for: bernstein book

Observer has an interesting profile of respected investor Howard Marks, excerpted from the book The Great Minds of Investing (found via Abnormal Returns).

I enjoy the writings of Howard Marks because his observations are logical and rational, and he doesn’t mind putting out stuff that is boring and hard to do. It is much more popular to write about exciting things that are easy to do like “sell all your bonds!” or “buy oil stocks now!”. This quote from the profile is a good example. (Bolding is mine.)

“You can’t control the environment,” Mr. Marks adds. So the key is to recognize how it’s changing, accept it, and respond as wisely as possible. “The screwiest thing you can do is to think you’re a Master of the Universe. We’re all just little cogs, and the universe will go on without us. We have to fit into it and adapt to it.” For example, at the time of our interview in late 2014, he sees scant investment opportunity and excessive complacency: “What bigger mistake could there be than to think you can safely get high returns in a low-return world?” Investors should adjust by assuming less risk and lowering their expectations. He cites a favorite quote from Peter Bernstein: “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.”

Assume less risk. Lower your expectations. I’ve been reading a lot of Dr. Seuss recently, and I think he would say “you may yawn and boo, but that is what you should do.”

For some reason, this book is out-of-stock at Amazon, unavailable at my library, and third-party copies are $70?! I believe this is because it contains high-quality photographs of the people profiled. Not to worry, Oaktree Capital has all of Marks’ famous memos online for free, or you can read a distillation of them in his book The Most Important Thing Illuminated (my review).

The following is a chart that I usually like to pull out during a crisis when people are scared of investing in the stock market, but since I just found a nicely updated version of it, I had to share. It is taken from Jeremy Siegel’s book Stocks for the Long Run and found via this Vox article about how most people incorrectly view real estate as the best long-term investment*.

Here is a chart showing the historical range of real (after-inflation) returns for US stocks, long-term bonds (bonds), and short-term bonds (T-bills) from 1802 to 2012.

The chart shows that over bried time periods, the stock market has been historically more of coin flip than anything else. Over a year, you could get anywhere from +70% to -40%. With bonds and cash, the swings are much less wild. But as you lengthen your holding period, your risk of losing money over that time decreases significantly. For time horizons of 20 and 30 years, only stocks never lost you money after inflation.

Note that the average annual returns for each respective asset class remains the same across all time periods. Via the CFA Institute:

This supports the advice that it doesn’t really matter as much what your plan is, but more that you pick one and stick with it. Going heavy on stocks and then bailing out when they are in a funk, or going heavy on bonds and bailing out when they are in a funk, all that is worse than doing NOTHING and simply riding it out. As they say, it’s not about timing the market, it’s about time IN the market.

I believe it was one of William Bernstein’s books that suggested that young folks who understand this should put as much money now into stocks as possible, as to increase your time horizon. Put 100% of your money into stocks now, and then as you get older put more of your money into bonds to get a balanced mix eventually. This can be hard though, as you’re asking the people with less experience and smallest assets to hold the thing that is most volatile. Going 80/20 or 70/30 from beginning to end is also a reasonable approach in my opinion (and personal experience with my own portfolio).

Now, another well-known professor Robert Shiller reminds us that the period above includes the most economically successful century of the most economically successful country in the world so far… and will not necessarily repeat itself. I’m not saying that you should expect 6% real returns from stocks. Shiller’s CAPE ratio model itself forecasts a 3% real return for stocks over the next decade. I’m focusing on the fact that stocks are investments in productive businesses and that the volatility of the pricing of such businesses will stabilize when held across longer holding periods.

* I would actually argue that the long-term return of real estate is actually not that far behind that of stocks, if you add in the imputed rent from the house. Yes, it may be true that the value of a house doesn’t increase that much over inflation over the long run. But houses are also productive in that they can create their own income! If the value of the rent that you could get from that house is included, that could add another 4% to 6% to the return historically. 5% real return would be smack dab between bonds and stocks.

If you’re trying to achieve early retirement, that means you have less time for compound interest and more time living off your investments. As a result, many early retirement investors like to own income-oriented investments like rental properties or dividend stocks. People used to own bonds and also be happy with that income when the interest rates were well above the inflation rate, but right now that is not the case.

So a good question is – How reliable is the income stream from dividend stocks? Joseph G. Paul of the AllianceBerstein blog tried to address this issues a couple different ways. First, he pointed out the dividend income from the S&P 500 went up in 39 out of the last 46 years. When it did drop, the largest single year drop was 20% from 2008 to 2009.

Now imagine that own the S&P 500 index or a High Divided Yield index (top 1/3 of S&P 500 by dividend yield) and simply spend the dividend income every year, but don’t sell any shares. 10 years later, would you have the same amount of money that you started with? (That’s what would happen with a 10-year bond.) Here are the results:

In fact, in 87% of 10-year periods that we surveyed, investors in equities got their money back receiving, on average, more than twice as much (Display) from a $100 investment. The high-dividend-yield portfolio was even more stable than the market as a whole, only failing to recover the initial investment in one out of 38 10-year periods.

The AB article makes a case for the suitability of a diversified basket of dividend stocks for long-term investors that want to spend the income every year without selling shares, with the warning that they also need the ability to ignore share price fluctuations and avoid selling in a down market.

On the other hand, financial author William Bernstein wrote in his book The Ages of the Investor that you can only treat 50% of your dividend income as absolutely reliable. His reasoning, at least as quoted from the book:

If you counted on your stock holdings to see you through retirement, you’re likely to be seriously disappointed. Yet, there is a small part of the equity portfolio that can be considered in the funding of retirement: the “safe dividend flow” from stock holdings. Although the value of stocks can fluctuate wildly, their stream of income is much more stable. At no point in the history of the U.S.stock market has its real dividend stream fallen by more than half, even during the Great Depression. During the most recent financial crisis, for example, although stock prices fell by more than 50%, dividends also dropped, but by only 23% from their peak, and only temporarily.

Here are some good reads about investing from this week:

How to Survive and Succeed Through a Bear Market
This letter to shareholders is written by John Montgomery, founder of Bridgeway Funds, which are a group of actively managed mutual funds with a reputation of high ethical standard and putting shareholders first. It provides his insights into investing and reminds us that there is also a risk when we only invest in safe investments. An excerpt:

This is my fourth* bear market as an investor, three of which have happened since I founded Bridgeway Capital Management in 1993. Even before the last three bear markets, I studied stock market data in detail going back to 1926. I spent quite a bit of time focusing on the downturns and thinking about how to survive them and why stock market investing is still very attractive even when predictably it doesn’t feel that way. From this research I formed five principles of long-term investing that became part of Bridgeway’s investment philosophy and are interwoven into our investment process. […] I thought I’d share what I learned with our investors.

When should you change your asset allocation strategy?
This post on the Bogleheads forum was written by Rick Ferri, investment portfolio manager at Portfolio Solutions and author of several good books on index and passive investing (including All About Asset Allocation). As a portfolio manager, of course he’s been fielding a lot of phone calls recently. Here are his thoughts for the general investor. An excerpt:

Significant changes to your stock and bond asset allocation strategy is a major decision and can be compared to changing careers. There are several good reasons to change your asset allocation strategy along life’s journey. Below are three reasons I believe a person has a legitimate reason to make an asset allocation change:

1) Your target retirement goal is well within reach.
2) You realize that you will not need all your money during your lifetime.
3) You have realized that your tolerance for risk is not as high as you once thought.

Why stock picking is a losing game
This article on CNN Money is by William Bernstein, another well-known portfolio manager and author of investment books such as the Four Pillars of Investing. Here he tries to remind us that just because the indexes are dropping, it doesn’t mean it’s time to switch to something that sounds better.

I’m sure you’ve heard that while it’s fine to ride the market’s gains when times are good, you need an expert stock picker when the bear roars. Wrong: Active money managers do not suddenly gain an extra 20 IQ point advantage over the rest of the market just because the Dow is falling. The record shows that their funds have trouble competing with the index in the bad times too.

Why do we think that the stock market will always go up? Why has it gone up over long periods of time historically? For instance, let’s look at this graph:

Source: A Random Walk Down Wall Street

There is one theory that I have read about in the writings of respected authors like Jack Bogle and William Bernstein. It states that there are three main components to long-term stock market performance:

Part 1: Dividend Yield
Obviously, if your stock distributes 2% in dividends each year, then you will have a 2% contribution towards of return.

Part 2: Earnings Growth
If earnings stay constant, then all other things equal, one would expect the share price of your company to stay constant as well. If the earnings grow by 5% every year, then your share price will grow by 5% per year. Thus, earnings growth rate is a vital component of total return.

These two parts added to together are coined the fundamental return:

Part 3: Changes in P/E Ratio
The price-to-earnings (P/E) ratio is the price per share divided by earnings per share. In other words, it is how much investors are willing to pay for each unit of earnings. If they are willing to pay 20 times annual earnings, the share price of the stock will be twice as high as if they only paid 10 times earnings. This part is denoted the speculative return, as it has changed throughout history:

Adding these two up finally gives you:

Predicting Fundamental Return
Now, what if your portfolio was all of the stocks traded in the United States? This would create a connection between the growth rate of the nation’s Gross Domestic Product and the earnings growth rates of all US companies. In other words, the fundamental return is based on GDP growth. In turn, the GDP growth rate is connected to population growth and productivity per person.

Here’s my quick take: If you invest in a globally diversified portfolio, do you believe that the world’s GDP will continue to increase in the future? I believe that this is a very good bet, and is a major reason why I continue to invest in the world markets with very low management expenses.

Some bad news: Now, from 1950-2000, fundamental returns were 10%: 4% dividend yield and a 6% earnings growth rate. These days, the S&P 500 has a dividend yield of only about 2%. Earnings growth rate estimates are subject to debate, but they hover around 6% still.

Predicting Speculative Return
However, the speculative return has greatly contributed to the high returns of the last 25 years for the S&P 500. This is due to a great increase of the overall P/E ratio of the stock market in recent history:

Source: Bespoke Investments

In 1950, the P/E ratio was only 7. During the dot-com bubble, it was over 40. Recently, the P/E ratio was as high as 24. It is very unlikely that this huge increase will happen again. So what does the future hold if P/E ratio either stay flat or fall? This will lead to a zero, and quite possible negative, future speculative return!

Source: Little Book of Common Sense Investing, Exhibit 7.1

Summary
In my opinion, the fundamental return is still a solid reason why stock prices will go up on the long-term, especially if you are not investing only in one country or economy. Some people call it a belief in capitalism, that economic growth will continue and GDP will continue to increase. I simply believe the the passion and motivation of all the people out there, from Sweden to China to Brazil.

However, there is good evidence that you might not be getting that 8-10% annualized return that many investment calculators seems to guarantee. You have to look at all the sources of expected future return, and the possibility of P/E ratio contraction.

But wait, why don’t people time the overall market based on P/E ratio? Some authors do recommend this. The problem is that the P/E ratio can also vary wildly for decades (see above), and most people don’t have either the patience or cash to fully see it through. For example, historically this has meant staying out of stock for 15 years at a time.

Will the P/E ratio ultimately settle at 15? 20? 30? 10? I have no clue. As the saying goes – the market can stay irrational longer than you can stay solvent. If it makes you feel better, as of this week, the P/E ratio is around 16. So the future speculative return from this point is starting to look more promising. 🙂

I feel like my last post about rebalancing wasn’t as thorough as I’d have liked it to be, so here I go again, adding some quick definitions and including a review of several research articles about the subject.

What is Rebalancing?
Let say you examine your risk tolerance and decide to invest in a mixture of 70% stocks and 30% bonds. As the years go by, your portfolio will drift one way or another. You may drop down to 60% stocks or rise up to 90% stocks. The act of rebalancing involves selling or buying shares in order to return to your initial stock/bond ratio of 70%/30%.

Why Rebalance?
Rebalancing is a way to maintain the risk/reward ratio that you have chosen for your investments. In the example above, doing nothing may leave you with a 90% stock/10% bond portfolio, which is much more aggressive than your initial 70%/30% stock/bond mix.

In addition, rebalancing also forces you to buy temporarily under-performing assets and sell over-performing assets (buy low, sell high). This is the exact opposite behavior of what is shown by many investors, which is to buy in when something is hot and over-performing, only to sell when the same investment becomes out of style (buy high, sell low).

However, in taxable accounts, rebalancing will create capital gains/losses and therefore tax consequences. In some brokerage accounts, rebalancing will incur commission costs or trading fees. This is why, if possible, it is a good idea to redirect any new investment deposits in order to try and maintain your target ratios.

How Often Should I Rebalance My Portfolio?
Some people rebalance on a certain time-based schedule – for example, once every 6-months, every year, or every 2 years. Others wait until certain asset classes shift a certain amount away from their desired targets before taking any action. A good source of research articles about which method is optimal can be found at the AltruistFA Reading Room. I’ve been reading through them the past few days, and I’ll try to provide a very general overview of the articles here.

So what is best? You may be surprised by the fact that not only is there no clear agreement on the answer to this question, but many of the articles actually contradict each other! For instance, compare this Journal of Investing article:

Over this period, regular monthly rebalancing returns dominated less active approaches. Should one infer that daily rebalancing is better still? Our data cannot say, but it seems plausible.

with this excerpt from an Efficient Frontier article:

So, what can we conclude from all this? Monthly rebalancing is too frequent. There are small rewards to increasing one’s rebalancing frequency from quarterly up to several years, but this comes at the price of increased portfolio risk.

Eh? I believe that this is because their results vary significantly with the time period chosen and asset classes being used in their back-tested scenarios.

Then there is this paper from Financial Planning magazine, which used the 25 year period from Oct. 1977-Sept. 2002 and a 60% Stock (S&P 500 Index) and 40% Bond (Lehman Bros. Gov’t Index) as the starting/target allocation. Here are the results for various rebalancing frequencies:

The various rebalancing periods showed minimal performance differences, although annual rebalancing held a slight return margin and a higher risk margin.

Because the risk-adjusted performance differences among the portfolios were small, the answer to the question of when to rebalance–monthly, quarterly, semi-annually, or annually–depends mainly on the costs to the investor of rebalancing.

Efficient Frontier’s Bernstein also agreed in the this last respect, stating “The returns differences among various rebalancing strategies are quite small in the long run.”

In the “wait for a significant shift before taking action” camp is author Larry Swedroe, who I think also presents a very reasonable solution. From a WSJ article:

With major holdings like U.S. stocks, foreign stocks and high-quality U.S. bonds, consider rebalancing whenever your fund holdings get five percentage points above or below your targets, suggests Larry Swedroe, research director at Buckingham Asset Management in St. Louis. For instance, if you have 40% earmarked for bonds, you would rebalance if your bonds got above 45% or fell below 35%.

Meanwhile, for smaller positions in sectors like emerging markets and real-estate investment trusts, Mr. Swedroe recommends a 25% trigger. So if you have 5% targeted for emerging-market stocks, you’d rebalance if emerging markets balloon above 6.25% or fall below 3.75%. “You definitely want to be rebalancing, but you don’t want to be doing it too often,” Mr. Swedroe says. “You want to let stocks go up a bit before you sell, but not so much that you lose control of risk.”

Summary
Since it seems that there is no concrete right answer, I think the most important thing is to just make sure you set up some way to rebalance that does not involve any emotions or market timing. Don’t worry about the details, but don’t let your portfolio run off on its own either. I think the subtitle of one of the articles above sums it up quite well… ‘Tis Better To Have Rebalanced Regularly Than Not At All.

I have personally chosen to rebalance annually. This method keeps it simple while still controlling risk and offering potential extra return. If I recall correctly, it is also recommended in Ferri’s book All About Asset Allocation (review).

Want more to read about investing? Here are two sites that have supplied me with a lot of good food for thought. I find these intriguing because while both are written by men well known for their financial acumen, they often sway far from those topics and can touch on politics, family life, and the pursuit of happiness in general.

Warren Buffett – Berkshire Hathaway Shareholder Letters
Every year, Mr. Buffett writes a letter to shareholders that discusses his company’s successes, mistakes, future moves, and a bit of everything else. Although I don’t view him as a deity like many others do, and have no plans to buy any BRK stock, I do find his writing to be easy to follow and often offers fascinating insights to a successful investor’s thought process.

However, I think one thing that people overlook is that Warren Buffett gets very intimate with many of the companies that he invests in, either with close relationships with the management or even by becoming the management for a while. He knows these companies inside and out, and can affect change within them. That’s something the common investor can’t easily emulate.

William Bernstein – EfficientFrontier.com Articles
In addition to being a practicing neurologist, starting a portfolio management company, and writing one of my favorite books on investing – The Four Pillars of Investing, Mr. Bernstein also writes a quarterly article on his website EfficientFrontier.com. It mainly discusses asset allocation, such as his thoughts on commodities, but has also wandered into areas like the housing market and estate taxes.

Here’s an excerpt from this most recent article:

If you want to pick your own stocks and bonds, be my guest. Just don?t imagine that making your decisions on the basis of publicly available information and analysis will lead you anywhere but to the poor house. You?re going to have to look at the primary data and analyze it entirely by yourself. And you?d better be good at it.

(This is the fourth in my series of Model Portfolio Comparisons.)

I hope people aren’t getting overwhelmed by all of these portfolios. Remember, the law of diminishing returns applies to investment complexity as well. After a while, adding more asset classes and mutual funds doesn’t get you that much more expected return. If you’re getting bored, try some of the earlier portfolios and tune out the rest. Personally, I don’t mind having 8 funds or so, and I’ve found that after the initial setup the maintenance is pretty minimal.

William Bernstein, both a neurologist and a founder of his own money management firm, is the author of the challenging but information-packed book The Intelligent Asset Allocator (my review). Here is one model portfolio for those that desire moderate complexity and high risk. The author warns that while this asset allocation has very high expected long-term returns, it will behave much differently than the S&P 500 fund that many people use as benchmarks.

Bold Investor Model Portfolio

Asset Allocation for 70% Stocks/30% Bonds ratio
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