AARP Interview: William Bernstein on Investing During the Coronavirus
How to think rationally about risk in a volatile market
William J. Bernstein is an author, investment adviser and retired neurosurgeon who takes a scientific approach to managing money. He's an eloquent proponent of modern portfolio theory, which holds that you're better off investing in low-cost index funds and allocating your money across broad types of assets — stocks, bonds, international securities and cash. His sixth book, Rational Expectations: Asset Allocation for Investing Adults, was published in 2014.
Q. How would you define an adult investor? Are most people capable of adult investing?
A. An adult investor is one who has approached the subject as any well-educated person would approach a serious field of study — by acquainting themselves with basic empirical and theoretical facts. Some of the prime things you'll learn are that most outperformance or underperformance by stock pickers and market timers is due to luck and not skill.
While some strategists make occasionally lucky-timing calls, there is no one in the history of investing who has reliably predicted market direction. Past superior performance rarely persists, and the most important predictor of future performance is fees and expenses, not investing genius.
In plain English, just as adults know there is no Easter Bunny or Santa Claus, investing adults know there is no Stock Picking Fairy or Market Timing Fairy.
Q. What do you think are the greatest short-term risks in a volatile market like this?
A. That markets will behave normally — in other words, that even a cursory survey of history reveals that price falls of 50 percent occur once or twice each generation and that even worse drops are possible. One time it'll be a banking collapse, another time a war, the next time an epidemic, and the time after that, something that no one has ever thought of before. Bear markets are as much a feature of markets as bull markets are.
Q. What are the largest long-term risks today, and how can one prepare for them?
A. One is financial panics, which tend to produce deflation, a period of falling prices. The other is long-term inflation. Obviously, you can't protect yourself completely against both, but you can partially hedge both by investing in short-term, high-quality bonds and by holding stocks, which are a fairly good inflation hedge in the very long term.
Q. Bonds have been the traditional diversifier for most portfolios, but it's hard to be too enthusiastic about them after a nearly 40-year bull market. What others would you suggest?
A. Hold your nose and buy them. There's a reason why Warren Buffett likes Treasury bills, even at a near-zero yield: [When things go awry in the financial system,] almost every other type of bond takes a haircut, and sometimes a very severe one. A half century ago, an analyst named Raymond DeVoe noted, “More money has been lost reaching for yield than at the point of a gun.” Securities that carry a government guarantee, like treasuries and CDs, allow you to sleep at night, to pay your bills when things really get grim, like now, and give you the courage to buy equities when it seems that everyone else is running away from them.
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Q. The biggest risk for a retired investor is running out of money. Is there a good rule of thumb for taking withdrawals?
A. Before age 70, you should spend no more than 3 percent of your portfolio a year; after that, you can increase that rate by perhaps a percent every five years. There's a trade-off, of course, between safety and spending. Most people, if they want to be as safe as possible, may have to live like monks; they can, conversely, have a good living standard, but only at the cost of risking an impoverished old age.
Q. If you had the power to change the nation's retirement system, what would you do?
A. The average person has as much business managing their retirement portfolio as they do taking out their child's appendix or flying their own airliner. (That's not an exaggeration; doctors and pilots are both notoriously bad investors.) I'd strengthen Social Security, and perhaps supplement it with a fully portable, low-cost, passively managed national pension system that can't be borrowed against and which carries the same legal protections as Social Security.