Editorial Note: Reading Bill Bernstein's 4 Pillars of Investing changed my financial life. I've since followed his writings and career and even met him at a Bogleheads Convention. He agreed to write a guest post for me once I got this blog up and running. Although some of it will be familiar to his past readers (he freely admits plagiarizing his own work) there are plenty of oldies but goodies here and some new gems as well. I now print it in its entirety free of commercial interruption:
Financial Advice to Young Physicians
Among financial professionals, physicians have a richly deserved reputation as miserable investors. The conventional explanations for this are that their practices are so demanding that they don’t have the time to do it properly, or that they’re too egotistical to take professional advice. For many, this is sadly true.
But all is not lost; learning how to invest properly doesn’t take an inordinate effort, and all but the most egotistical of surgical personalities can learn to suppress their overconfidence. Medical practice, as you well know, is a profoundly humbling experience to anyone with a breath of intellectual honesty; the best doctors soon come to the conclusion that the more they see, the less they know.
The same, not surprisingly, is true in finance. The main reason that physicians are rotten investors is that it never occurs to them that finance is a science, just like medicine. Day-to-day medical practice is profoundly scientific, informed by a vast amount of underlying research; nowadays almost no drug or surgical treatment is adopted without rigorous trials comparing it to other accepted treatments or placebo. In short, most physicians would not commence a treatment for so much as a cold without a good deal of experimental and statistical evidence in back of it.
The most important work is reported in prestigious peer-reviewed periodicals such as The New England Journal of Medicine and Lancet. The key term here is “peer reviewed.” Nothing appears in these high-level periodicals without being vetted first by the top experts in the field—requests for multiple extensive revisions are routine.
Unfortunately, when doctors put on their investing hats, they completely forget their scientific training. There is, in fact, a rich and informative scientific literature about what works and what doesn’t in finance; it is routinely ignored. Instead of depending on the Journal of Finance (the investing equivalent of The New England Journal of Medicine), they get their advice from USA Today or worse, from their stockbroker.
Of course, I’m only picking on my former colleagues for fun—in this regard doctors are no different from lawyers, retail clerks, or anyone else. What’s truly scandalous is that even most finance professionals are unaware of the scientific basis of investing.
What is certainly true, however, is that unless you spend some time to learn, if you will, the anatomy, physiology, pathology, and pharmacology of finance, you are a sitting duck for every stock broker and financial advisor who comes down the pike.
What to do? Nothing, absolutely nothing, until you acquire some financial expertise. Fortunately, it’s not that hard. You will have to do some reading. This will take several months; take your time, for the hours you spend acquiring this knowledge will make you more income, on a per hour basis, than even the most productive ophthalmologist, neurosurgeon, or cardiologist can produce in their respective special procedural heavens.
Those of you who are seeking investing enlightenment are not going to find much of it on the Web. I suggest you log off, power down your computer, and read some books. Take your time. The months you spend perusing this list will be well spent. I'd recommend reading at least the first four books listed before even thinking of getting your hands dirty with real investing.
1. The Millionaire Next Door, by Thomas Stanley and William Danko. This is not a book about investing, but something far more important: saving. If you have to live in a McMansion, drive a Porsche, and wear $2,000 suits, you are condemning not only yourself, but your children to poverty; if you cannot save a high percent of your income, it does not matter even if your name is Warren Buffett.
2. A Random Walk Down Wall Street, by Burton Malkiel, is an excellent investment primer. It explains the basics of stocks, bonds, and mutual funds, and will teach you the all-important efficient market concept.
3. Devil Take the Hindmost, by Edward Chancellor. You simply can't learn enough about market history, and Chancellor's story of boom and bust in the capital markets, beginning in the 17th century, is pure mind candy. In my more cynical moments, I often think that investing is an operation in which wealth is transferred from those who do not know market history to those who do.
4. Common Sense on Mutual Funds, by Jack Bogle. It provides as much detail as you could ever want about this important investment vehicle. Mr. Bogle is the founder and retired chairman of The Vanguard Group, and has been an important voice in the industry for decades. Beautifully written, opinionated, and highly recommended.
5. Global Investing, by Roger Ibbotson and Gary Brinson. This is a beautifully written volume on the history of investible assets. An informed investor cannot know enough about market history, and this is the best single source in this area. Want to know: what the returns for US stocks have been in each of the past 200 years? The price of gold for the past 500 years? Interest rates and inflation for the past 800 years? It’s all here. As implied by the title, the authors also provide an excellent perspective on the place of foreign assets in a diversified portfolio, and provide some worthwhile insights on portfolio theory and the efficiency of the marketplace.
6. Value Averaging, by Michael Edleson. An extremely useful how-to guide on deploying a lump sum of money among multiple assets. Finally back in print as a Wiley Classic Edition.
Once again, take your time—even a year or two if necessary—to read these books. The time will be well spent, and you will be, by the end of the reading list, more than well prepared to efficiently and expertly invest on your own.
William Bernstein
Editor's Note: If you'd like to read more from Bernstein, consider his five excellent books below. He might also be willing to manage your money, but the $25 Million minimum will keep most physicians off his client list. However, a mere $25 will get you all the books below which just may, in the end, be worth hundreds of thousands of dollars to you as they were to me. His blog, although now discontinued, is also worthy of a few hours of your time.
The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize RiskIntroduction to Investing Books)
The Four Pillars of Investing: Lessons for Building a Winning PortfolioMoney & Monetary Policy Books)
The Birth of Plenty: How the Prosperity of the Modern World was CreatedWorld History Books)
A Splendid Exchange: How Trade Shaped the WorldWorld History Books)
The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in BetweenInvesting Books)
Disclosure: I have no financial relationship with Dr. Bernstein. But if you buy anything from Amazon from the links on this page I'll get a small commission (at no additional cost to you.)
Awesome post! Thanks to Mr. Bernstein for writing, and good job WhiteCoatInvestor for getting him.
More like this! Less Nigerian and random newsletter scammers.
Dr Bernstein appropriately highlights the importance of an evidence-based approach to investing as well as medicine. I particularly agree with his statement that “what’s truly scandalous is that even most finance professionals are unaware of the scientific basis of investing.”
It’s true that you can outperform the majority of “financial professionals” simply by ignoring them, since they often perform at a worse than chance level. Over years as an investor, I’ve found that in fact it can be possible to outperform significantly by carefully studying objective peer-reviewed data such as the following, and applying an evidence-based approach based on the results.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=225375
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2358
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1757025
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1289357
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=984382
Those 5 papers all talk about the benefit of a value tilt to the portfolio a la Fama/French. I agree that the evidence is compelling, and have a significant value (and small) tilt to my own portfolio. No guarantees for the future, of course, but worth a bet IMHO.
Hi WCI,
I started investing and following the bogleheads’ approach recently. I was wondering what you thought of my novice portfolio.
Age 37, married (wife 31), 1 daughter (age 1)
Annual Salary: 325K (federal marginal rate 33% and NYS marginal rate 6.85%, I also pay NYC income tax, ouch!)
Assets: $166,755 + Emergency Fund
Debts: lease car (reimbursed from work) + no mortgage (rent) + no credit card debt; wife has $20k in student loans but she wants
to pay off herself once she returns to work
My financial plan is to retire by age 66, save 20% of my gross income yearly with an aggressive portfolio (80% stocks/15% bonds/ 5% cash).
I also intend to purchase a home within the next 1-2 years (our parents will give downpayment as a gift) and pay for private college for (most likely) 2 kids.
I am maxing out my 403b, started backdoor Roth x 2 (me, wife), almost maxed out 529 and will be eligible for 457b next year. I cannot do a stealth IRA with HSA.
I have appropriate term life, disability, car and renter insurance and currently looking into umbrella insurance and will/trusts.
Investment assets: $166,755
[Taxable accounts]
Vanguard Div Growth VDIGX $19669
Vanguard Total Bond Admiral VBTLX $13850
Vanguard Total International Stock Admiral VTIAX $28754
Vanguard Total US Stock Admiral VTSAX $33493
[Tax Deferred Accounts]
-Roth IRA
Vanguard Div Growth VDIGX $12456
Vanguard Bond Market Admiral VBTLX $6102
Vanguard Total Stock Market VTSMX $5212
– 403b
Vanguard Target Fund 2045 $32219
– Wife’s Roth (done as backdoor 2012)
Vanguard Target Fund 2045 $5000
– Cash: ING/Capital One Checking $10000
My questions are:
1) Do you have any general comments on my asset allocation?
2) I have read about having a multiple of one’s annual salary based on age: e.g. 1X salary at age 35, 3X salary at age 45 … 8-11X annual salary at retirment (depending on who you read). I am currently nowhere near that and will not be able to reach even the 3X salary target at age 45. However, I have been saving 20-23% of my annual salary for the last two years and think that I will be able to continue this for the long term. Is this savings rate appropriate?
[I anticipate needing 70% of my pre-retirement income, having no mortgage, and most likely will NOT live in a no state income tax state].
3) I have also read about having one’s age in percent bonds. I am at 80% equities, 15% bonds, 5% cash. I feel that since I did not have the earlier years to save (when I was in training), I can and need to be more aggressive since I am still 29 years away from retirement. Is this a wise move?
Thanks for your wisdom and again, great website.
Jason
1. I think an 80/15/5 asset allocation is okay given your age, time to retirement, and amount of assets. Keep in mind that Benjamin Graham recommended you never have more than 75% stocks or less than 25% stocks. He was a smart guy and I’d give consideration to that guideline. When in doubt, err on the side of less aggressive. You can always bump up the risk after the next market downturn when you know you can tolerate it. Overestimating your risk tolerance is far worse than underestimating it. I’m not sure about the way you’re implementing your chosen allocation across your various accounts. Perhaps if you could pin down your desired asset allocation a little better it would be easier. For example, how much do you want in international stocks, small stocks, REITs etc. If all you want is “80% stocks” you could just put all your stocks into a total stock market index and have a very simple portfolio. You might try reading Ferri’s All About Asset Allocation or Bernstein’s 4 Pillars of Investing to learn more about building an asset allocation.
2. Who cares what someone else thinks? All that matters to you is your goals and where you’re at in relation to them. 1X, 7X etc has nothing to do with that. If you’re saving 20% you’ll be fine. That’s quite appropriate.
3. Not necessarily, but given that your portfolio is relatively small, I think it’s okay to be 80% stocks for a while AS LONG AS YOU CAN TOLERATE LOSING HALF OF THE VALUE OF YOUR STOCKS IN A BAD BEAR MARKET. The only way to know if you can, is to go through a bad bear market.
Don’t worry too much about asset allocation. In the beginning, savings rate matters so much more than you can almost ignore your asset allocation. Anything reasonable is fine. Also, are you sure you need 70% of your gross income in retirement? I think you’re wrong. I bet that number is less than 50%, and maybe as low as 25%. Check out this post on the subject:
https://www.whitecoatinvestor.com/percentage-of-current-income-needed-in-retirement/
Hi WCI,
Thanks for the reply.
1) My goal was to have a portfolio of 80 percent equities (0.6 domestic, 0.4 international) and 20 percent bonds. I don’t know enough about REITs to invest in them.
I agree that my portfolio is a little messy. The reason why there is such a large percentage of dividend producing stocks is that I was confused during the 2011 euro crisis and thought that it was a “safe” place to put my money. I will most likely sell those and move into a simpler portfolio.
2) I really enjoyed your column on percentage of annual income needed for retirement. I also agree that I will most likely need much less but I will also be likely in a high cost-of-living area (NYC metro) and cannot move due to family reasons. It might be 60% or even 50% but not 30 or 40% (I wish!).
3) Have you ever thought about turning your writings into a book? I think just the sections from First Timers/ Retirement and Personal Finance would make a great book.
Glad to be of service. I’ve written 3/4 of a short book this month. I think I may try my hand at self-publishing later this year.
Great post as always. So I’m trying to decide on which order to read Dr Bernstein’s books. I’ve read online that the Investors Manifesto is shorter and a sort of primer for 4 pillars. Would you agree? And where should the Intelligent Asset Allocator fit in? Thanks in advance.
If you can get through 4 pillars, I’d read that instead of the Investor’s Manifesto, but both are good and cover similar ground. Don’t tell Bill, but I’ve never read the Intelligent Asset Allocator. I like the shorter new series too, at least what I’ve read of it.
I can +1 WCI’s take on Dr. Bernstein. Stumbled across his Intelligent Asset Allocator book back in Fellowship, and it changed my life forever. It was like suddenly I understood how this investing thing ACTUALLY worked, and it was from that point forward I started shifting to an indexed strategy. Have since read most everything he has written, and if you like history, his historical books are lovely reading.
Always hoped I could meet the good doctor in person and thank him for changing the course of my life. He is truly a hero of mine.