I have always enjoyed reading personal finance and investing books. My favorite investing book is The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Berstein. After reading it, I have felt that most other investing books didn’t quite measure up as the topics were better covered in Bernstein’s book. Most of my investing strategy is designed around what I learned in this book.
The four pillars according to Dr. Bernstein are theory, history, psychology and business. He strongly suggests being an A+ student of all four if you hope to be a successful investor in the modern day marketplace.
The first pillar, Theory, is a fundamental concept that adds to your scientific awareness of investing when you understand the correlation between risk and return. The higher your exposure to the risk of loss, the greater your earnings. He ascertains that investing is a social science that must keep up with the behavior of society as well as movements of the overall market place. Under the same heading of “Theory” is diversifying, which investors traditionally do very poorly. If a portfolio is truly diversified properly, the investor is better protected from sharp declines in the market.
The second pillar, History, calls attention to the fact that there is a reference for the performance of the market place. The market follows a generally consistent set of reactions in response to certain historical events. The successful investor studies this history and understands how cultural events affect stocks, bonds, real estate values and other asset classes. To support his view, Dr. Bernstein points out the often irrational behavior of the investing public when these events occur. He shows how the invention of new technology has created an environment of point-and-click investing which in turn has led to the rise of the less thoughtful private investor.
When he approaches the subject of the third pillar, Psychology, he ventures to expound on the behavior of the point-and-click investor’s state of mind and the mentality of investors as a whole. He believes that the most common behavior of investors leads to overconfidence, unreasonable buy and sell decisions, overzealous trading and paying far too much for low value shares. He states that investors should, “Confront your own dysfunctional investment behavior”.
As he addresses the fourth pillar, business, he points out that investors can often be too trusting, allowing stockbrokers to lead them by the nose into poor investments recommended by advisors or their own self-serving reasons, not for the client’s benefit. Urging that the world of finance is a profit generating business and much of it is focused on generating commissions for the company; not as much energy is focused on generating profits for the client. He contends that although they have a fiduciary responsibility to their clients, they are free to make decisions that function outside that realm on a day-to-day basis.
The four pillars, theory, history, psychology and business take a close look at how the public selects investments and our response to holding or selling them in tumultuous times. Dr. Bernstein uses humor and education to illustrate his points. His book is a well researched book, factually, which looks closely at the historical behavior of the market and its current state. He gives common sense advice for what it takes to gain some degree of success as an investor.
Dr. Bernstein doesn’t recommend any particular sector for investing, but he does encourage true diversity of the portfolio. By approaching investing as a science that needs to be studied to understand, he arms the reader with the power to grasp their contribution to managing their own wealth accumulation. The best aspect of this book, The Four Pillars of Investing: Lessons for Building a Winning Portfolio is its ability to arm the investor with the tools needed to not only survive the market, but also thrive in the market.