Book Review > The Investor's Manifesto

In “The Investor’s Manifesto,” author William J Bernstein tells us that a successful investor requires four main qualities – an intrinsic interest in the process of investing, substantial mathematical abilities particularly in probability and statistics, knowledge of financial history, and emotional discipline. He estimates that about one in 10,000 people possesses all four. In spite of this, more and more people are taking on major investing decisions for themselves that will determine their financial futures. This is because more ordinary people are being exposed to market based superannuation and retirement products of increasing complexity and they feel pressed to make their own decisions. Many prefer to trust their own unskilled judgement rather than submit themselves to a financial industry that they have come to trust less and less.

Bernstein is scathingly critical of most areas of the financial services industry and doesn’t hesitate to use the most strident language. “If you act on the assumption that every broker, insurance salesman, mutual fund salesperson and financial advisor you encounter is a hardened criminal, you will do just fine.” Bernstein describes investing as a “life and death struggle with the financial services industry.” Consequently he deplores the fact that so many people are unwittingly and inappropriately being forced to be their own fund managers when they lack the knowledge and expertise.

This is not a book about how to get rich. It is about “minimizing the odds of dying poor”. The author’s central piece of advice is to avoid the financial services industry since its various advisers and agencies always put their own business interests before those of their clients. They have no sense of fiduciary duty or responsibility. He also says they are largely unqualified to provide advice and the advice is totally contaminated by other interests. He sees the financial services industry as a main factor in increasing your likelihood of poverty.

As for taking personal responsibility for investing, the book is also a warning about the dangers of overconfidence and the game we play with ourselves that we might just that little bit smarter than the rest of the pack. Bernstein repeatedly puts paid to any delusions you might have in that department. "In the investment world, you are not above average. You are likely not even close."

Consequently he sees individual share ownership as a pathway to poverty. Personal share trading is doomed to failure since 90% of the time you are playing against institutional traders who are vastly smarter, faster, harder working and better equipped than you are. In the end they will always win. “Trading individual stocks is like playing tennis against an invisible opponent; what you don’t realise is that you are volleying with the Williams sisters.”

Investment newsletters and tipsheets were not spared either from Bernstein’s invective. He says that they are all, without exception useless and inaccurate. In fact he tells us that U.S. statistical research shows that the best way to make money from them is to take the worst newsletter and do the absolute opposite of what it says. This gives far better results than following the best newsletter.

Bernstein does have positive suggestions for the average person though. Firstly he summarises his warnings and concerns in three general principles for investment. Don’t be too greedy, diversify as widely as possible, and always be wary of the investment industry. He also advises that you must always save. "Save as much as you can, and do not stop saving until you die."

But when it comes to investment strategy he is adamant that there is only one approach. Only invest in index funds and bonds. The index funds, which should only be based on major indices of mainstream developed markets, provide the greatest diversity, lowest fees and keep you safely clear of the ravages of the financial services industry. The bonds are there for security. (Bernstein does not discuss doubts about the risk-free reputation of government bonds in a post-GFC world). Bonds also tend to perform inversely to the sharemarket over time.

The proportion of index funds to bonds in your portfolio should be determined by “your age in bonds”. For instance, if you are 60 years old, you should have 60% bonds and 40% index funds. The ratio can be bent a little depending on your risk tolerance. But a most crucial part of the strategy is to rebalance the bond-equity mix in your portfolio each year around this ratio. This way you are forced lighten over-performing assets and buy underperforming ones. He demonstrates that this contrarian approach provides a substantial boost in portfolio performance.

It is refreshing to hear Bernstein’s gloves-off criticism of the financial services industry. It’s a theme that will resonate with many AIA members who are driven to develop their own investment expertise and strategies out of deep and increasing suspicion of financial advice and products. But as a personal investor who is doing the absolute opposite of what he suggests, I found Bernstein’s message deeply disturbing. Especially against a backdrop of global financial uncertainty, Bernstein really did make me wonder if I knew what I was doing. I’m sure this is exactly what he set out to achieve.  “The Investor’s Manifesto” is essential reading.

Michael Stearn is a member of the AIA. A video interview with the author can seen at http://www.amazon.com/gp/mpd/permalink/mS5ULDF0ABDMG.