Saturday, 24 July 2010

Book Review: The Investor's Manifesto by William Bernstein

Author Bernstein's advice in the Manifesto repeats in condensed form what Burton Malkiel says in the classic A Random Walk Down Wall Street - save lots of money to be sure to have enough, set aside an emergency fund, diversify investments and buy and hold passive index mutual funds or ETFs.

Though the advice is very conventional in the above sense, certain passages are very worth reading for their succinct and clear explanations, especially the discussion on how to assess bond values taking account of interest rates and default rates and how to estimate future stock returns using the Gordon dividend yield equation.

The book's style and layout, with sidebars, highlighting, end of chapter summary points, illustrative charts and tables, make it easy to read and understand. In general, the author succeeds in presenting the material at a level for the intelligent but relatively uninformed layperson.

There are certain places where Bernstein introduces things without preparing the reader, which I think could easily leave a non-expert asking him/herself what else is lurking out there that might not have been mentioned. In chapter 6 Building Your Portfolio, Bernstein presents model portfolios for several example investors. The portfolios are excellent in that they get right down to fund companies and fund names. The problem arises in the fact that when discussing Taxable Ted, for example, his model portfolio includes tax-exempt municipal bonds, whose usefulness is indeed properly explained but ... the munis are introduced for the first time in this portfolio and one is left thinking about other possible investor situations and wondering about products not covered in the text that might be helpful.

Age = Bond Allocation and Retirement = Zero Human Capital Arrrgghhh! Bernstein uses these connected, and in my opinion, near useless ideas (p.76) as the starting point for asset allocation. Consider Arthur Rubinstein, great pianist of the 19th and 20th centuries. He gave his last concert at age 89. and died at 95. Given that a) his human capital aka ability to earn money never really stopped and, b) he was likely rich enough to have more than sufficient to fund whatever lifestyle he desired, should he ever have held a bond allocation equal to his age? His case illustrates the obvious fact that almost no one goes brain dead and physically decrepit the day they retire. Why bother with the wrong rule when equally simple questions allow one to go direct to the correct principles - ability to earn cash flow = bond type income, which can be capitalized into a "portfolio allocation" plus, how much of your wealth do you need for essential living expenses? and how soon, which directs you to investments with similar stability like bonds.

Caveat for Canadians - the book is material for a US audience, using references to US mutual funds and products (e.g. tax-exempt muni bonds don't exist here, unfortunately) tax accounts and the like.

Armageddon = 2008 crash? I was really intrigued on reading the book's sub-title "Preparing for Prosperity, Armageddon and Everything in Between". Prosperity is covered in the book. But gimme a break! The word Armageddon means a decisive and catastrophic conflict. 2008 might have been, perhaps was close, but it wasn't catastrophic. Armageddon would have been the case if the financial system had collapsed in the autumn of 2008. How about countries like China, Russia, Germany where revolutions and wars wiped out governments and bondholders along with stock markets? What investments would have provided protection then?

The book (p.9) has a very interesting graph of Venetian bond prices from 1300 to 1500. The Venetian state's bond prices fell from par to as low as 19% of face value after a disastrous war, and did not get back to par for 100 years. Who can wait 100 years for recovery? The book's advice to hold bonds for safety may not be so wise in a context wider and longer than the last century or two of the United States. Are US treasuries / bonds really risk-free? What if they are not, what then should the investor do? One possible investment - gold - receives no attention or consideration. The oft-derided bubble-justification statement that "it is different this time" may not be much worse than the counterpart "it is the same this time", which assumes that market crashes will always mean revert to positive returns in fairly short order (e.g. twenty years or so).

Being prepared for all scenarios, including Armageddon, surely depends on the principle espoused in the book, namely diversification, but on a much wider scale than simply stocks and bonds - assets like gold/silver and human capital enhancement.

Overall, this book is a well-written shorter repeat of Malkiel's Random Walk but has no outstanding features to make it a compelling alternative. My rating - 3.5 out of 5.

1 comment:

Financial Cents said...

I'm surprised, I "heard" this was a good read? I'll take your word for it. Cheers.

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