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Four Pillars, part 4

You understand investing theory, you’ve studied financial history, and you’re aware of psychological pitfalls. Now the last hurdle: the investing industry. Although improved over the last two decades (since the first edition of Four Pillars in 2002), it can still be a minefield for the unaware and the trusting. Understanding and navigating the investing industry is Bill Bernstein’s Fourth Pillar.

A few key principles:

1) “Avoid financial cable programs [and] newspaper business sections.” These do not provide you with an edge. Something on television or in the headlines is already in the price. The financial media “perpetuates the myths and false promises of stock picking, market timing, and asset allocation fairies.”

2) Be wary of stories or analogies. We are persuaded by stories, which is why they are so often used to sell us things (insurance, thematic funds, etc.) (see Part 3). “Fools listen to stories; the wise crunch the numbers.” Better to ask for data/numbers to support any claims and ask questions until you have the full picture.

3) Remember that your investment advisor* is not your friend. You pay them! Just because someone seems likable and/or trustworthy doesn’t make them worthy of your trust. As Bernstein notes, there are few standards for investment advisors. If you work with an advisor, make sure you have a clear and complete understanding of all the ways they make money and any conflicts. And work with a fiduciary.

4) Be suspicious of portfolio complexity. As clients’ knowledge of fees has improved, some advisors now build needlessly complex portfolios (20+ mutual funds or ETFs). This complexity may make it seem like they are adding value, but they aren’t. You can get diversified exposure with a few funds (or even one). There are also advantages to a simple (but diversified) portfolio if you manage your own investments.

5) “Do not purchase insurance products for investment.” Use insurance to insure against catastrophic outcomes – for example, term life insurance if you have others that rely on your income. Complex insurance products “come with high fees, hefty surrender charges, and the risk of payout reduction.” Opacity and complexity hide their full, true cost, and these products mainly benefit your “agent’s wallet.”

6) Build the core of your portfolio with low-cost index or systematic funds. Pay attention to fees and consider taxes. Avoid individual stocks and expensive actively managed funds or ETFs. We’ve known that active managers underperform for decades. And active funds do not protect you in bear markets.

7) As an individual investor (even with tens or hundreds of millions of dollars), you do not need private equity or private real estate. There are exceptions, sure, but private funds mostly offer higher, often opaque fees and less liquid exposure to asset classes you can access with low-cost, public options.

This is a lot, I know. But, if you’ve made it this far, you are on your way. If investing on your own, you can build a well-diversified portfolio with a few mutual funds or ETFs. Or, with some homework, you can find a knowledgeable financial advisor that can help (see Flag posts below for more information).

In Part 5, I’ll put the pieces together.

*for more on advisors, see Financial Advisor Red Flags and Financial Advisor Yellow Flags

Related posts: Part 1 (on theory), Part 2 (on financial history), Part 3 (on psychology), Part 5 (closing thoughts).

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