Bill Bernstein understands how the human brain works, yet he says he still has trouble persuading investors to make good decisions.
Bernstein spent 15 years as a neurologist in Coos Bay, Ore., before writing the book that made him a guru for do-it-yourself investors: “The Intelligent Asset Allocator. How to Build Your Portfolio to Maximize Returns and Minimize Risk.”
Since that time, Bernstein, now 72 years old, has written a series of books on investing, world trade, the roots of prosperity and most recently on financial bubbles. His latest book is “The Delusions of Crowds: Why People Go Mad in Groups.” He is on the board of the John C. Bogle Center for Financial Literacy, and is a co-principal of Efficient Frontier Advisors, a boutique investment-advisory firm.
If that seems timely given today’s frothy stock market, he says he’s not yet worried. He says that asset bubbles will keep inflating and popping and, besides, today’s market isn’t nearly as overvalued as in the late 1990s before the dot-com crash.
Yet Bernstein is hardly a market cheerleader. Because of high valuations, he has a bearish prognosis for equity returns over the next 30 years. Even so, he says there is nowhere better to put your money right now than the stock market. We’re entering a low-return world, and we should make the best of it.
We reached Bernstein at his home in Portland, Ore. An edited version of our conversation follows.
Barron’s: Are bubbles inevitable?
Bill Bernstein: Yes. Bubbles are the inevitable outcome of human nature.
What part of human nature?
We are the ape that imitates. So when enough people around us become euphoric about the stocks, that euphoria gets critical mass and spreads throughout humanity.
We are the ape that seeks status. And what better way to get status than to get richer than your neighbors?
We are the ape that tells stories. We always prefer narratives versus facts.
Are we in a bubble now?
That’s a much harder question. First of all, large-scale bubbles are extremely rare. In my lifetime, I’ve only seen one up close and personal. The most spectacular one was the late ’90s, when a large number of people, perhaps the majority of investors, thought they were all going to become effortlessly rich by investing in tech stocks and internet stocks.
Smaller bubbles in smaller asset classes are relatively common. At the moment, there’s a plethora of them….Bitcoin and so on. But they are relatively small scale.
Barron’s Retirement Q&A
You aren’t alarmed by the sky-high price-to-earnings level of the S&P 500?
What I’m really more alarmed about is what is behind it, which is very low interest rates. Without low interest rates, the stock market wouldn’t be where it’s at.
What sort of stock returns do you see in the coming years?
I can tell you stock returns are going to be lower than they’ve been for the past three decades. Annual returns are going to be in the range of 4% to 6% nominal over the next several decades.
I can’t tell you what they’ll do over the next decade. That’s too short a time. It’s entirely possible over the next 10 years, we’ll see stock returns at 10% or 15% annualized, and it’s entirely possible we’ll see 0% returns.
Are there other areas that you see as more attractive places to invest than the stock market right now?
No. The expected returns are crummy, but the equity risk premium over bonds is about the same. It’s usually about 4 or 5 percentage points, and that’s probably what you’re going to be getting.
Your original Coward’s Portfolio was 25% large-cap stocks, 25% small-cap stocks, 25% foreign stocks, and 25% bonds. Is that still a good way to build wealth?
I think so. That’s a nicely diversified portfolio. Less important is what stock allocation you pick. Far more important is being able to stick with it. Once you’ve come up with a reasonable plan, then you have to stick with it.
Do you worry that so much of market capitalization comes through a few big tech stocks like Apple, Google, and Microsoft?
A little bit. It’s not unusual. If you go back to the ’70s and ’80s, the oil companies were an enormous part of market capitalization. I worry a little but not terribly much.
Isn’t there a risk in owning bonds with interest rates so low? If rates head up, bond prices will drop.
There’s a risk. And the question you have to ask yourself is whether you’re being compensated for that risk. And the answer is maybe not. The only truly safe investment out there in the short term is Treasury bills.
Building a nest egg is a simpler exercise than spending it down. What advice do you have for people in retirement?
The very first advice I give people is for God’s sake, unless you and your spouse are in bad health, you should do everything you can to delay taking Social Security until 70 [when benefits reach their maximum]. The biggest risk you have as a retiree is that you’re going to live too long.
With bond yields so low should retirees be buying income annuities?
Yes. I like single premium immediate annuities, nothing fancier than that. But don’t even think about getting one until you’ve deferred Social Security to age 70.
You made your reputation by recommending low-cost index funds. But your latest book is called “The Delusion of Crowds.” That seems like an argument not to own index funds.
I’m not sure that’s the case. If I suppose if you want to connect the book with my investment philosophy, it’s a book about why people don’t do the right thing. They invest in hot mutual funds because it seems like the right thing to do, but in the end it’s not.
As a neurologist, you know how people’s mind change as they age. Should older people be simplifying their investments?
They should be putting them on auto-pilot. That’s where a target date fund or life strategy fund is an excellent idea. Just shovel in money every week or couple weeks, don’t look at your statement, and in 30 years you’ll have a nice retirement.
Simplifying isn’t only good when you’re old. It’s good when you’re young, too.
How is your own money invested?
Very complexly. If you read my book, I believe there is an excess return over the market for value stocks and small stocks. And it’s worked out well in the long term, but not over the past decade.
What are your actual percentages in different asset classes?
I’ve always been close to 50/50 stocks and bonds, and I divide that pretty evenly between domestic and foreign stocks. I overweight small stocks and value stocks.
I think foreign stocks will outperform domestic stocks. I think that’s a 55% to 60% probability, so don’t bet the farm on it.
Who is hurt by today’s high asset prices?
If you’re somebody in my age range, you’ve had the benefit of four decades of spectacular returns.
Younger investors don’t have those assets built up, and they’re looking at lower expected returns going forward. The millennials are going to come for baby boomers with pitch forks. Quote me on that.
You spent many years training to be a doctor. Why did you switch into investing?
The public perception is that neurology is a fascinating field where you’re dealing with the brain all day. Where in fact, everyday neurology is a lot of rote pattern recognition and it’s easier to get bored than most people would imagine. That was half of it. The other half was 3 a.m. emergency-room calls.
Does being a neurologist help you in the investment world?
Not really. To understand how people behave doesn’t give you any help on how to overcome it. The part of my education that was much more valuable was simply my scientific training. You try to challenge your hypotheses with data, and you change your mind when they don’t match.
Are you still licensed to practice medicine?
I let it lapse. I found I was losing my expertise. Letting your medical license lapse is a really emotional decision. It was really hard.
You’ve done medicine and investing. Any thought of a third act?
Well, the third act is writing historical nonfiction. The last finance book I published was in 2014. Since that time, I’ve written two long-form history books, and I certainly intend to write more.
Thank you, Bill.
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