William Bernstein: Investing is half mathematics, half Shakespeare

Updated: Oct 18

One of the smartest advocates of low-cost, evidence-based investing is the neurologist-turned-investment-adviser William Bernstein. He is the author of several books, including The Intelligent Asset Allocator, If You Can: How Millennials Can Get Rich Slowly, and The Delusion of Crowds. A new edition of his best-known book, The Four Pillars of Investing, has just been published.

Bill this week makes his third appearance on The Long View podcast, produced by Morningstar, and we highly recommend you listen to it. Here are seven key takeaways.

Investing is half mathematics, half Shakespeare

“The older I get, the less I depend on the mathematics of investing and the more attention I pay to the psychological and the emotional aspects of investing. There are a lot of people out there who can talk the talk inside of a spreadsheet, but when it comes time to walk the walk, when it looks like the world economy is going to shut down or the banks are going to go kerplunk, they don’t do so well.

"Half of investing is mathematics, and the other half is Shakespeare. And what I mean by the Shakespeare of investing is the fact that history, particularly economic and financial history, but geopolitics as well, is a very cruel mistress. And the other part of Shakespeare is the biggest enemy you have in investing, which is the face that’s staring back at you in the mirror. And if you’re the kind of person who can solve differential equations or do continuous time calculus as easily as most people brush their teeth, and you ignore the Shakespeare half of investing... you’re going to have your head handed to you.”

Ensure your portfolio is one you can execute

“Yes, compounding is magic, but you have to observe Charlie Munger’s prime directive of compounding, which is never to interrupt it… You have to design your portfolio with the worst 2% of the time in mind so that you don’t interrupt compounding, which basically translated into plain English means that you probably should have more safe assets than you think you should have. In other words, a suboptimal portfolio that you can execute is better than a stock-heavy optimal one that you cannot execute.”

Beware anyone who attracts extensive media coverage

“Anytime someone is so charismatic that they get wall-to-wall media coverage, be on your guard. That’s not to say that Warren Buffett and Elon Musk are going to blow up. But more often than not, when you see wall-to-wall coverage of a money manager or of a corporate CEO, you have at least a 50% probability of encountering a major fraud on their road… If you think about the coverage that Cathie Wood has gotten, that Elizabeth Holmes has gotten, that Sam Bankman-Fried got, those were all warning signs.”

Investors are more likely to stick with boring funds

“How far short do mutual fund investors fall from the actual return of the fund? So, just ordinary total stock market funds do pretty well. They have a pretty small gap on the order of about 0.5% or 1%. When you look at sexy growth stocks, that gap rises, and when you look at tech stocks, the gap is probably double digits. At the other end of that spectrum are target-date funds, and I’ve seen some data that suggests that the dollar-time-weighted gap for target-date funds is actually negative. That is that the investors in these funds actually get a slightly higher return than the return of the fund itself, and that’s simply because these funds are so dull.”

There is no asset allocation fairy

“What happened back in the 1970s and ‘80s and ‘90s is people fell in love with mean-variance optimisation, the Markowitz algorithm. And it turns out that the inputs to that produce enormous changes in the outputs and that the algorithm, if you’re going to use historical returns, then favors the asset classes with the highest returns. What happens is, because of mean reversion, that gets thrown into reverse going forward. Because of mean reversion, the best-performing asset classes have a slight tendency to be the worst ones going forward. And so, if you apply the Markowitz algorithm, you are probably going to plant your face... There’s no one black box or technique that is going to give you the best forward optimal asset allocation. The best thing you can do is to pick an allocation that’s reasonable and then stick with it. That’s better than using a black box.”

Young investors should avoid being fully invested in stocks

There is a wonderful quote from Fred Schwed’s marvellous book, And I’read it: “There are certain things that cannot be adequately explained to a virgin, either by words or pictures, nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.” What tends to happen to at least a lot of people is that they read about stocks having long-term returns, they go 100% equity in their 401(k), and then they get slammed with a 2008-09, and they swear off stocks for the rest of their life… You have to first find out who you are before you become an aggressive stock investor.”

Four questions to ask if you’re approaching retirement

“The person who is approaching retirement has to ask themselves four questions. Number one, what is their burn rate? Is it 1% or 2% or is it 5% or 6%? And the higher your burn rate, the more conservative you should be and the more you should favour annuitising products… The second thing, of course, is how old are you? Someone who wants to retire at age 40 better have a fairly aggressive allocation with a very low burn rate. The third thing, of course, is their risk tolerance. And then, the fourth thing, which relates to the risk tolerance, is how they balance off safety versus a bequest. For example, do you want to endow a wing at the hospital? Well, then you should invest very aggressively, and you better have a fairly low burn rate. On the other hand, if you’re primarily concerned about your safety, then you want to have a more conservative asset allocation.”