If you were pining for a How-To guide on investing, this chapter is for you. Bernstein - no matter how much he says that this is not the book to use for it, gives us a simple Intro to Portfolio Building and its rather useful.
CH. III - The Nature of the Portfolio
To arrange ones portfolio, one must figure out two major issues:
- The overall allocation of stocks and bonds
- The allocation among stock asset classes
First however, Bernstein explains that bond/stock allocation is dependent on age. It is the most important factor. The second most important is risk tolerance. One tends to go hand-in-hand with the other.
Commonly, a portfolio (should) look something like this:
YOUNG = 80⁄20 stock/bond - Young people have time and earning potential on their side.
OLD = 30⁄70 stock/bond - Aging means a need for security.
Those distributions are Bernstein’s recommendation. Of course, this is not the final answer for everyone. Some people have a higher risk tolerance (e.g. because they are wealthy or have a safety net) than others (e.g. because they have experience with a bull market or a financial disaster, war or social crisis).
On a personal note, while my partner was born into a stable economy without a history of upheaval, I was born into the opposite. This has shaped our opposing tolerances for financial risk taking and required us to come to a compromise on our shared investment strategy. Conversely, this has made both of us more attentive to the task.
It’s time for some portfolio theory.
Rebalancing is on the menu. The gist is simple: buy low, sell high according to your percentage ratio. This means in practice that if one’s original ratio was 50⁄50 and stocks have been soaring to 70⁄50; one may want to sell 20% of one’s stocks so things are nice and refined again. The point of this is to keep risk at the level one has determined to be tolerable.
The next course serves asset classes. Crudely put, there are four asset classes that matter: U.S. Stock, Foreign Stock, Bonds and REITs. These can be further compartmentalised into large market U.S., large value U.S., small market U.S. and small value U.S. and into Foreign developed large market, Foreign developed marge value*, Foreign developed small market and of course, Foreign developed small value. *The Foreign Stocks can also be subdivided into Foreign emerging large market stocks and Foreign emerging marge value stocks.
This seems like a lot of categories but no one requires you to make it complicated. In fact, Bernstein points out, complex portfolios are not useful for low amounts of investment capital. If one has a high amount of capital, on must still consider ones tolerance for complexity.
If the above categories seem too complex (and there was no inclusion of commodity funds (gold, soy etc.), mortgage-backed securities, cryptocurrencies, mutual funds, ETFs, hedge funds, private equity…), keep it simple and invest into those categories you actually understand.
If this seems boring, you are on the right path. Exciting investments are usually bad investments (think of lottery tickets), unglamorous companies on the other hand must offer higher eturns to be attractive to investors.
Nations too, should not be judged by their ability to incite awe. If a country has a rapidly growing economy, it will likely prove to have low stock returns.
Also, don’t try to be clever. It is wise to assume that everyone else is smarter and more hard working than oneself. Overconfidence is expensive.
Now, Bernstein gets serious: Do not, he says, invest with any mutual fund family that is owned by a publicly traded parent company. He is adamant about this and to get his point across, he gives us a quick breakdown of different, common fund companies.
Vanguard Group = The only fund company which is neither publicly traded nor privately owned.
Privately-owned fund companies:
- Fidelity Investments = owned by the Johnson family
- founded in 1949 by Edward C Johnson II
offers low-priced passively managed funds
The American fund = owned by Capital Group Companies
uses “load fees” to scam °
Bernstein nevertheless considers them disciplined (if nothing else)
° I had to research what this loading scam was beyond the book. What I glean is that such load fees are sale charges made prior (front-load) or post (back-load) or in a combination of the two at the initial purchase of an investment. It is done to pay the commission of a broker. It’s not a good deal, especially if one is charged front-loaded fees.
- Dimensional Fund Advisors = cofounded by David Booth & Rex Sinquefield
- operates by employing Fama’s efficient market hypothesis
- all funds are passively managed & weighted to small and for value stocks
- high fund fees (due to the privately-owned status) and high advisor fees
He only briefly mentions the existence of Britain’s Barclays and publicly-traded fund company BlackRock (the largest investment management company in the world).
His advice is clear: invest only with nonprofit mutual fund companies, which at this time in history, appears to me, Vanguard.