My Warren Report

The Gist: The origin story of an investing superhero.

The first of a two-part review of multiple Buffett biographies.

Access the second part here: Warren Piece.

 

A few years ago, a close friend invited me to a weekend enjoying the finest that his home state of Nebraska had to offer: steak, a unicameral legislature, and the Berkshire Hathaway annual shareholder meeting.  We ate well, ran into the Governor while he was out walking his dog, and mostly had a great time shooting guns and talking by the evening fire at the farm.

Carhenge

Figure 1. Sadly, we missed Carhenge, a Nebraskan’s reconstruction of Stonehenge using cars.

 

But the weekend opened with a visit to the Woodstock of capitalism. By the time we arrived at the basketball arena where it was held – before 6 AM, more than an hour before doors were to open – the line circled the million-square-foot building several times and appeared to include the entire population of Nebraska (and perhaps a couple neighboring states). Once finally inside, you could partake in the Berkshire conglomerate’s diverse products: Dairy Queen Blizzards, cowboy boots, auto insurance, private jet gift cards, and much more. Yet the real treat was being able to ask any question you’d like of Warren Buffett, one of the greatest investors of all time. In this email, we’ll explore the origin story of this investing superhero.

Make money

Figure 2. The vibe was a bit different than 1969. Less hippies, more yuppies. Less heroin, more ritalin. Less free love, more free markets. 

 

Warren was born in Omaha in 1930 and his earliest “hobbies and interests revolved around numbers.” He saw their magic everywhere, even becoming skeptical of religion when he calculated in church that hymn composers did not live longer than average. Wall Street Journal reporter and biographer Roger Lowenstein relates that the jump from math to money was early: “When Warren was six, the Buffetts took a rare vacation to Lake Okoboji, in northern Iowa, where they rented a cabin. Warren managed to buy a six-pack of Cokes for twenty-five cents; then he waddled around the lake selling the sodas at five cents each, for a nickel profit.” By age 7, Warren begged Santa to give him the nearly 500 page then-definitive book on bonds. At age 10, his father Howard offered to take him on a trip to the east coast (something he did with each of his kids) and Warren naturally wanted to see the New York Stock Exchange. At 11, Warren was confident enough to buy his first stock – and got his sister in on the deal. She tormented him as the stock price dropped and, when it recovered, he sold at $40 for a small profit. The price then zoomed to over $200 and he vowed never again to be so oriented toward the short term. 

There was one idea in particular that gripped Warren’s young mind: compound interest. He understood and appreciated early on what Albert Einstein called the most powerful idea in the universe: every nickel he saved might, with enough time, benefit from growth and growth on that growth, and end up being worth much more in the future. Warren would imagine his future riches and ask, “Do I really want to spend $300,000 for this haircut?” With that in mind, Warren soon announced he would be a millionaire by 35 – the equivalent of a kid today saying he’d be worth $18 million.

Scissorsz

Figure 3. Presumably back then each strand of hair was individually cut with bejeweled gold scissors by specially imported barbers who required luxury accommodations and all-expenses-paid during the multiple day process. No wonder kids wound up growing their hair out!

 

Warren’s hero was his father Howard, whose portrait would hang prominently in his office. Howard’s principal passion was politics and he had wanted to become a journalist but his father Ernest, having paid his college tuition, insisted that he get a more commercial job. So Howard joined a bank – which turned out to be not to be as stable as imagined once the Great Depression took hold. When the bank failed, Howard asked for a job at his father’s grocery store. Ernest replied he already was employing one son and couldn’t hire another – but he’d let Howard run a tab at the store so his family could eat. Howard then made the extraordinarily bold move to start his own stock brokerage at a time when no one wanted to buy stocks. Despite the headwinds, the business quickly turned a profit and served as an early hangout for young Warren, who often fled the house to escape the wrath of his mother, who had significant mental health issues.

Fishing pole

Figure 4. The Buffett clan was known for their God-fearing debt-fearing pinch-every-penny austerity. After a long day’s work, Ernest would dictate to Warren a memoir – “How to Run a Grocery Store and a Few Things I Learned About Fishing, feeling these were “the only two subjects about which mankind had any valid concern.” Buffett reported that “I’d write it on the back of old ledger sheets because we never wasted anything at Buffett and Son.”  

 

In 1942, Howard volunteered to be the sacrificial Republican nominee for Congress and, to the surprise of everyone, including the candidate, won. Richard Nixon would soon be the Buffetts’ neighbor but Howard was the Ron Paul of his day and “considered only one issue in voting on a measure: ‘Will this add to, or subtract from, human liberty?’” Concluding that most proposals were subtractions, Howard voted for very little, instead hopelessly crusading for a return to the gold standard and a more humble foreign policy. Above all, Howard was known, in politics and out, as a man of unflinching ethics, refusing “a raise because the people who elected him had voted him in at a lower salary.” He always carried a piece of paper inscribed “I am God’s child. I am in His Hands. As for my body—it was never meant to be permanent. As for my soul—it is immortal. Why, then, should I be afraid of anything?”

Warren initially did not like Washington but soon made the most of it by insisting that his father get him every book – literally, the number ended up being in the hundreds – the Library of Congress had on horse handicapping. While Warren made some money at the tracks, he made far more with a paper route, eventually delivering “almost 600,000” papers. Not content with merely delivering the Washington Post, “he asked all his customers for their old magazines as scrap paper for the war effort.” Warren then checked the magazines for their subscription expiration dates, established a card system for tracking all his customers, and sold them renewals for commission. From these efforts, Warren was making more money per year than any of his teachers and, bored at school, taunted them by shorting the AT&T stock they had their retirement savings in. Despite his smarts, Warren’s grades were mediocre – until Howard told him he’d have to give up his profitable paper route and instantly the marks improved. Yet Warren was still entrepreneurially restless, redirecting his paper profits into operating pinball machines in local barbershops, renting out a 40 acre tenant farm back in Nebraska, and experimenting with whatever money-making scheme he could conjure. By 16, he wondered why the heck he would want to go to college when he was making so much money.

Spite

Figure 5. A deeply under-studied strategy is investing for spite. Thumb your nose / stick out your tongue / see how it goes / in the long run!

 

Howard insisted, so Warren went off to Wharton, where he was, again, completely bored. “His professors had fancy theories but were ignorant of the practical details of making a profit that Warren craved.” About the only notable aspect of his time there was his arrangement “with the Philadelphia Zoo to ride an elephant” down a main avenue to celebrate the expected victory of Republican Thomas Dewey in the 1948 presidential election. Dewey, of course, did not beat Harry Truman, and the carnival stunt had to be canceled. More close to home, his father Howard lost his congressional seat, probably due to his rare vote for successful legislation – Taft-Hartley – which, among other related labor reforms, forbade unions from compelling employers to only hire their members. Though Howard would briefly return to Congress, he was part of the Robert Taft wing of the Republican Party and Dwight Eisenhower’s Nebraska allies oversaw the end of his career. Howard would spend the remainder of his life back at the stock brokerage, worried about the country’s bad choices.

Elephant

Figure 6. Modern zoos are really missing out on the profits involved in renting out their animals to college students.

 

Warren thus transferred home to the University of Nebraska and graduated at 19 to get it over with. Warren considered an alternative education far more practical than college: Dale Carnegie. Till now, Warren had always been an argumentative contrarian but 

“He decided to do a statistical analysis of what happened if he did follow Dale Carnegie’s rules, and what happened if he didn’t. He tried giving attention and appreciation, and he tried doing nothing or being disagreeable. People around him did not know he was performing experiments on them in the silence of his own head, but he watched how they responded. He kept track of his results. Filled with a rising joy, he saw what the numbers proved: The rules worked. Now he had a system. He had a set of rules [for winning people over]”

More significant to his future, Warren would soon get the practical financial education he craved. Still running his various side rackets, Buffett confidently applied to Harvard Business School – and got rejected. Reconsidering his options, Buffett successfully applied to Columbia Business School, where he could study with the Wall Street legend of that era now known as the father of value investing: Ben Graham. Graham would become his personal mentor and give Buffett the intellectual foundation for his future success. 

Born in 1894 to a comfortable life, Ben Graham’s introduction to the stock market had been unpleasant: his widowed mother had over-borrowed to play the market and been wiped out in the Panic of 1907. His family was saved, in his own words, “from misery, though not from humiliation” by the generosity of relatives. Undeterred by his childhood experience, Graham went to Wall Street and started making a name for himself – then lost 70% when he assumed Black Tuesday 1929 was the bottom and borrowed to buy in. Still undaunted, with everyone else scared of stocks, Graham saw bargains. Over the rest of his career, he assembled one of the best long-term Wall Street records ever, beating the market average by about 2.5%. Buffett biographer Alice Schroeder advises “That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result.” Incredibly, Lowenstein reports that “the figure, though, does not include what was easily its best investment, its GEICO shares, which were distributed to Graham-Newman’s stockholders. Investors who kept their GEICO through 1956 did twice as well as the S&P 500.”

Graham made no secret of his approach and in fact considered investing just another intellectual exercise along with the study of classics, the suggestion of novel inventions, and the seduction of women. He claimed that he wanted to do something foolish, something creative, and something generous every single day. Graham endlessly annoyed his business partner by sharing in real time his insights about stocks with his Columbia business school class. His still-popular book, the Intelligent Investor, inspired Buffett to apply to the school in the first place

At the core of Graham’s philosophy is the attempt to buy a dollar for fifty cents. Graham advised that all companies have an intrinsic value derived from their actual business operations but detached from the price that people are willing to pay for them at any given time. Graham intoned that “you are neither right nor wrong because the crowd disagrees with you” and that “in the short run, the market is a voting machine. In the long run, it’s a weighing machine.” At the most basic level, a value investor would look for companies trading at a small multiple (say, 1.5x) of or even less than their book value – that is, the value of the company if all of its assets were liquidated. Graham initially got famous in the 1920s by buying lots of shares in an oil pipeline company who he realized owned bonds of 50% greater value than the company was selling for on the stock market – and then putting himself on the board and distributing an enormously profitable dividend. Buffett quips: “Price is what you pay, value is what you get.”

Graham conjured the analogy of an obliging but manic Mr. Market who is always prepared to buy or sell stocks, often at nonsensical prices. Jason Zweig summarizes: “The intelligent investor is a realist who sells to optimists and buys from pessimists.” “The secret of getting rich on Wall Street,” Buffett told a class of his own, is “try to be greedy when others are fearful and… very fearful when others are greedy.”

Capitol

Figure 7. Unfortunately, while we can often profit from Mr. Market, we can often suffer from Dr. Democracy, who is subject to similar nonsensical swings unless slowed down. 

 

Because you can’t anticipate when Mr. Market will be manic or depressive, Graham says “selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook.” The market can remain irrational for longer than you have capital. The opposite side of the equation is preferable, but “buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.” Graham’s advice to derisk was to buy so cheaply so as to create a “margin of safety.” As Buffett would later say in one of his famous shareholder letters, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” For Graham, to do otherwise would be a game of chance – or speculation that some greater fool would pay more than you. “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” And, if the stock market is too expensive, trading at large multiples of an average of the past few years’ earnings, Graham advised to buy bonds instead (indeed, Graham instructed never to own less than 25% bonds nor less than 25% stocks, adjusting the exact split in contrarian spirit to buy low and sell high)

Fight club

Figure 8. Buffett would also say that the first rule of investing is don’t lose money. The second rule is to remember the first rule. But the truth is that the first rule of value investing is that you don’t talk about value investing. Don’t let other people in on your bargains. The second rule is the same. The third rule is that someone yells “STOP!” when the market is too high and buying is over. The fourth and fifth rule have to do with concentrating your investments. The sixth rule: No shirts, no shoes. The seventh rule is that investments will go on as long as they have to – be patient for that return. And the eighth and final rule: if this is your first time value investing, you have to buy something cheap.

 

When Buffett met Graham, Schroeder records that “the rest of the class became the audience to a duet.” Lowenstein relates what happened after graduation: “Having racked up the only A+ that Graham had awarded in twenty-two years at Columbia, Buffett made what seemed an irresistible offer: to work for Graham-Newman for free.” But Graham turned him down – the Wall Street firms did not hire Jews, so he only hired Jews. Deflated, Buffett returned to his father’s company to be a stockbroker, unhappily a salesman rather than an investor. But Buffett kept in contact with Graham and, after a couple of years, Graham relented and invited Buffett back to New York.

In that era, market information was relatively scarce – there were no quick Google searches to discover endless reams of data about stocks. So instead Buffett was put to work endlessly reading annual reports and financial information to discover bargains in the depths of the market. Graham’s methods were remarkably mechanical. He was almost myopically focused on a company’s balance sheet and almost indifferent to what a company actually did for its money – if anything, knowing more might constitute a distraction from the opportunity. When Buffett or another would present a stock, “Graham would decide on the spot whether to buy it. It wasn’t a matter of persuading Graham. A stock either met his criteria or it didn’t. He did it by the numbers… when anyone tried to talk to Graham about a company’s products, ‘Ben would look out the window and get bored.’” Buffett soaked up everything he could but, within a couple of years, Graham decided to quit while he was ahead and returned capital to investors.

Buffett was not going to return to stock salesmanship so, despite cautions from his father and Graham that the stock market was overpriced, he opened up his own investment partnership. It had two unusual aspects. First, he based himself in Omaha at a time when “no serious American money man worked anywhere but New York City.” Second, Buffett offered not the friendliest terms: he would give investors an annual summary of results but not tell them anything they were actually invested in and he’d only allow them to take out money once a year on December 31. Otherwise, investors would receive 100% of profits up to 4% and 75% of any profits that Buffett generated thereafter. Around Omaha, the initial whisper was that he was a sophisticated conman. And, to be fair, this is the kind of thing that lured investors to crooks like Bernie Madoff. 

But Buffett wanted to spend more time analyzing stocks than having to explain and defend to his average investor why he had money in unwanted, problematic, or broken companies that were therefore cheap to buy shares in. As incredible as it may seem, by then, “Buffett was familiar with virtually every stock and bond in existence. Line for line, he had soaked up the financial pages and the Moody’s books; day after day, he had built up a mental portrait of Wall Street.” He later advised that the secret to success was to read “Read 500 pages every day. That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” It wasn’t easy but “intensity is the price of excellence.” That intensity, Schroeder says,

made him burrow into libraries and basements for records nobody else troubled to get. He sat up nights studying hundreds of thousands of numbers that would glaze anyone else’s eyes. He read every word of several newspapers each morning and sucked down the Wall Street Journal like his morning Pepsi, then Coke. He dropped in on companies, spending hours talking about barrels… or auto insurance… He read magazines like the Progressive Grocer to learn how to stock a meat department. He stuffed the backseat of his car with Moody’s Manuals and ledgers on his honeymoon. He spent months reading old newspapers dating back a century to learn the cycles of business, the history of Wall Street, the history of capitalism, the history of the modern corporation. He followed the world of politics intensely and recognized how it affected business. He analyzed economic statistics until he had a deep understanding of what they signified. Since childhood, he had read every biography he could find of people he admired, looking for the lessons he could learn from their lives… He ruled out paying attention to almost anything but business—art, literature, science, travel, architecture—so that he could focus on his passion. He defined a circle of competence to avoid making mistakes… He never stopped thinking about business: what made a good business, what made a bad business, how they competed, what made customers loyal to one versus another. He had an unusual way of turning problems around in his head, which gave him insights nobody else had… In hard times or easy, he never stopped thinking about ways to make money. And all of this energy and intensity became the motor that powered his innate intelligence, temperament, and skills.

Some friends, family, and acquaintances – around Nebraska or associated with Graham – saw something in that intensity and invested. If you had been crazy and lucky enough to invest $10,000 at the beginning and had stubbornly stuck with him, you’d have over $500 million today (versus over $5 million if you had gotten the market return). But even by the sixties, Omaha now whispered that Warren Buffett could make you rich. Per Buffett’s childhood vow, by 35, he was a millionaire – worth over $50 million in today’s money. 

Buffett was doing it by applying Graham’s principles about intrinsic value – but also learning new things along the way. As a new generation started trading on the stock market, fears of another crash disappeared and the market began to get frothy – especially about new technology. With tech trading at crazy multiples, Buffett pledged to his partners that “We will not go into businesses where technology which is way over my head is crucial to the investment decision.” (And while you hopefully can see that this was prudent, you also should know that he declined the opportunity to invest in Intel when given a special opportunity to do so at the beginning). At the same time, with an ever-increasing amount of capital to put to work, it was harder to find bargains that Buffett could take advantage of without moving the entire price – so he contemplated buying entire companies. But as Buffett got more involved in the operations of the companies he bought into, he understood better why they were so cheap: they really did have significant problems. And yet he’d be hesitant to get rid of a company that still generated a return – even if it was measly – because he resisted confrontation and enjoyed the collection.

Mcdonalds

Figure 9. Turns out the incredible savings of eating every meal at McDonald’s are overwhelmed by later medical expenses.

 

But Buffett thought that if he could get management right that the value would pay off. Knowing relatively little about the underlying businesses, even after much research, he tried to find the right kind of obsessive. He loved to tell the story of when he bought a grocery store chain and convinced the owner, Ben Rosner, to stay on to manage the asset. Rosner was so consumed with his business that, when he went to a black tie event at the Waldorf Astoria and ran into a rival, he started asking him all about what prices he paid for different goods and discovered that he was paying a lot cheaper price for toilet paper. Rather than gloat, Rosner thought something was wrong and immediately left in his tuxedo, drove out to one of his warehouses, tore open a box and individually counted the sheets of toilet paper, discovering that his vendor had screwed him over, providing less sheets than promised.

Following the Graham playbook, Buffett would eventually acquire a controlling stake in a Massachusetts textile manufacturer called Berkshire Hathaway, whose stock was selling at a 2.5x discount to its liquidation value – presumably plenty of margin of safety. But Berkshire was in an extremely tough industry that would eventually leave the United States but by then had already basically left the northeast and fled south. Partially because of uncooperative management who was idealistic about making textiles and not money, Buffett got mad enough to buy them out. Putting in his own team, he explained “the basic theory of return on investment. He didn’t particularly care how much yarn [Berkshire] produced, or even how much [it] sold. Nor was Buffett interested in the total profit as an isolated number. What counted was the profit as a percentage of the capital invested.” This was wise direction, but there was too much headwind in the industry. He would ultimately reflect: “I would have been better off if I’d never heard of Berkshire Hathaway.” 

And yet Berkshire would be his destiny: in 1970, after years of warning investors that he could not sustain his track record amidst the Go-Go years of an overheated market, he closed his partnership and offered to return all capital. With the market so crazy, Buffett said he would invest his own money in municipal bonds – and Berkshire Hathaway. For some lucky investors, knowing that Buffett would be in control was enough to roll over their investment into Berkshire. When the market came down again, Buffett told people now was the time to get rich and he would use Berkshire to propel his further investments. But he also partnered with the man who would redefine his investment style, building on and adjusting from Graham: Charlie Munger. 

More on that partnership and the rest of Buffett’s career in our next correspondence.

Snowball

Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money. A former insurance analyst, she spent over 5 years working on this book, interviewing hundreds of people who knew Buffett. More or less authorized, Buffett told her “Whenever my version is different from somebody else’s, Alice, use the less flattering version.” Unfortunately for their relationship, she apparently used a few too many versions different from Warren’s memory – but it still comes across as a tribute to the man. Published in 2008. 

Buffett

Figure 11. Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). A Wall Street Journal reporter and Berkshire investor, he spent three years working on this biography, published in 1995. Some of his descriptions of politics seemed off and he is very dismissive of academic commentary on Buffett’s investing history, but it’s a good book!

Intelligent investor

Figure 12. Click here to acquire Ben Graham’s The Intelligent Investor (8/10) – appropriately, Buffett’s purchase of the book had an outstanding rate of return. This version has commentary from Wall Street Journal columnist Jason Zweig after every chapter offering additional context through the early 21st century. Graham distinguished between an entrepreneurial investor – like Buffett – who would have to put in a ton of work to find bargains and a defensive investor who was just trying to get the market return. While there is timeless wisdom here, Graham found it harder and harder to apply his mechanical rules even in his day and it’s only become harder. Toward the end of his life, he recommended the average investor defensively invest in index funds, then a new-fangled instrument of John Bogle’s, now a standard offering.

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I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

    Say No To The Glow

    The Gist: 7 specific, escalating steps to spend less time with your favorite screen.

    The second of a two-part review of multiple books, most notably Tech-Wise Family.

    Access the first part here: Intervention.

     

     

     

    So, you’ve decided to say no to the glow and yes to life. Maybe you want to remember what your family looks like (without Instagram filters). Perhaps you want to actually get some work done (maxing out your skill points in real life). Or you just want to chase that great American birthright: the pursuit of happiness (amazingly, guaranteed before the advent of screens!)

    We are going to go over some digital hacks and tips but Cal Newport, the author of Digital Minimalism and Deep Work, will tell you “what you need instead is a full-fledged philosophy of technology use, rooted in your deep values, that provides clear answers to the questions of what tools you should use and how you should use them and, equally important, enables you to confidently ignore everything else.” 

    The underlying truth of Newport’s warning is that technology is ubiquitous, convenient, and, as we discussed in our last correspondence, designed by the world’s smartest people to keep you using it for as long as profitable (i.e. forever).  You will ignore casually set intentions too easily – so, whether in a moment of frustration or clarity, you need to identify the good, the bad, and the ugly of your relationship with technology.

    Clint Eastwood

    Figure 1. Note that in the original, “Good” was relative. Clint played a corrupt bounty hunter who abandoned his business partner to die in a desert. Up to you whether to move anything analogous in your own life into another category.

     

    Crucially, along the way, focus on what technology is substituting for. You justify social media to keep track of friends – but how often are you having really meaningful conversations? You explain that you always need your phone in case of an emergency – but how often is the real emergency your boredom? You ironically defend television as “unplugging” – but how often have you watched a few too many episodes and find yourself more exhausted than when you started?

    Outlet

    Figure 2. To be clear, if your way of unwinding is to sit on your couch watching a blank, unplugged TV screen, that’s probably ok – though don’t miss the excitement outside of seeing grass grow!

     

    When you are tired, when you are procrastinating, when you are bored, when you are lonely, the digital world has practically limitless offerings. And yet these glittery mind tricks don’t deliver. As you feel the cue, remember that there are more satisfying alternatives. Stanford psychologist Kelly McGonigal reports that the American Psychological Association has found that the least effective strategies for stress relief include playing video games, surfing the Internet, shopping, and watching TV or movies (along with gambling, drinking, smoking, and eating). The most effective stress relief? “Exercising or playing sports, praying or attending a religious service, reading, listening to music, spending time with friends or family, getting a massage, going outside for a walk, meditating or doing yoga, and spending time with a creative hobby.”

    “If there is a secret for greater self-control, the science points to one thing,” McGonigal reveals. “The power of paying attention. It’s training the mind to recognize when you’re making a choice, rather than running on autopilot.” And, as James Clear articulates especially well, your goal is to make the desired choice easy and the undesired choice hard. Embrace a cascade: start at whatever level you think is appropriate and, if you falter, make it harder. Below are suggestions for your phone, your computer, and your television.

    Starting with your phone:

    You want to access apps when you want, not when they want.  

    1. Reorganize and replace your apps. On your home screen, keep only single use tools (like maps, calendars, weather). At first, you can try to bury deep in folders your endless apps (social media, games, news, video). Replace your temptation with a better alternative: Where YouTube once tempted, you now have Spotify. Where you once tapped Candy Crush, you can now tap Kindle to read the last book I reviewed. Where Facebook once sat, you now have a list of people to call (starting with your mom!). If social media is your particular temptation, Newport concedes that “refusing to use social media icons and comments to interact means that some people will inevitably fall out of your social orbit—in particular, those whose relationship with you exists only over social media. Here’s my tough love reassurance: let them go.” For the people you really care about, upgrade your approach: “When your friends and family are able to instigate meandering pseudo-conversations with you over text at any time, it’s easy for them to become complacent about your relationship. These interactions give the appearance of close connection (even though, in reality, they’re far from this standard), providing a disincentive to invest more time in more meaningful engagement… Being less available over text, in other words, has a way of paradoxically strengthening your relationship even while making you (slightly) less available to those you care about. This point is crucial because many people fear that their relationships will suffer if they downgrade this form of lightweight connection. I want to reassure you that it will instead strengthen the relationships you care most about. You can be the one person in their life who actually talks to them on a regular basis, forming a deeper, more nuanced relationship than any number of exclamation points and bitmapped emojis can provide.”
    2. Turn off all notifications. Restart at zero and then extremely sparingly restore the absolute bare minimum. I myself just have notifications for my phone calls and emails. 
    3. Go grayscale. App developers make very intentional color choices to attract your attention – there’s a reason why notifications are in red. Deny them the privilege and take back control.
    4. Place your phone somewhere it will take a few minutes to retrieve from. You may not be able to always do this, especially if your work requires call availability – and, if that’s the case, you can move up the cascade. But the vast majority of people can keep their phone away from arm’s reach for far more time than they do. (Added bonus: limit police searches!) But for your day to day life, Andy Crouch puts it nicely: “We [should] wake up before our devices do, and they [should] ‘go to bed’ before we do.” At the very least, buy a traditional alarm clock and banish your phone from your bedroom. You can also slow yourself down a little bit by disabling Touch ID and requiring a password or putting a rubber band around your phone to remind you not to endlessly scroll. I take a cue from Tristan Harris – the background of my phone says “Do not open without intention.” 
    5. Limit time on your apps. Phones now have powerful built-in tools that can warn you about the time you are spending on applications and can function as speed bump reminders if you try to access apps outside of a designated time (the morning, when you should be working) or if you use apps in excess (only 15 minutes a day or whatever you decide). Exploring the features of Apple’s Screen Time or Google’s Wind Down is well worth the effort – and you can ratchet your process up with apps that block your access altogether. As you contemplate the appropriate time limits, consider the results of Tristan Harris’ study of 200,000 iPhone users about what apps made them feel happy or unhappy after use. The unsurprising bottom line: you’ll tend to be happier after using meditation, fitness, and book apps; you’ll tend to be unhappier after using social media, dating, and game apps. 
    6. Purge your apps and give away your passwords. Cal Newport suggests that, in order to truly understand your temptations and what substitutes look like, you should take a 30 day detox (not just of your phone but of anything digitally tempting). After it’s over, similar to the notification process, only extremely sparingly add back anything you think is truly beneficial. Don’t purge every few weeks in frustration – only to add back temptations a short time later. Determine what you are better off without, change the password to something complicated and impossible to memorize, give the password to a disciplined loved one, and delete the apps. The authors of Make Time go so far as to delete email and web browsers from their phones because they think that those functions are better handled on computers but even that step can be easily reversed by a phone with the functionality. Bizarre to me, some of the digital monks I discuss find texting acceptable (sometimes justified because it’s a social interaction).  Personally, I find the data on how quickly people read and respond to texts alarming in light of the goals of digital restraint. Unfortunately, my phone provider doesn’t have a plan without texts and the app can’t be deleted, so I use the time limits described above to only see them rarely.
    7. Dumb down your phone. If you really, truly want to end your phone’s distractions, then get a dumb phone with few functions (including, alas, texting). I have not made it this far down the cascade – I enjoy too much settling arguments with instant internet access – but going this far, as extreme as it seems today, could be rewarding on net.
    Phone

    Figure 3. Our new Paleotechnology Program allows you to live as your ancestors did! Travel way back to the 1990s when most humans had to contend with landlines! Experience life as it was intended in such cinema classics as Citizen Kane: in black and white! Along the way, enjoy all the mystery and wonder of real human contact!

     

    For your computer:

    you want to be able to focus and work when you need to, and you also want to embrace the benefits of the real world, especially socializing. 

     

    1. Consider alternative relief. Keep a copy of the list of activities above that the American Psychological Association actually deliver on stress relief. Whenever you are tired or bored and tempted by surfing the web, online shopping, or gaming, fight the mind trick and try something else, if only for a half hour. If you’re procrastinating, think about the consequences of NOT doing whatever you’re putting off and just get started with the smallest step you can take toward progress.
    2. Demand quality. This particularly applies to gaming, and it will come up again for TV. There’s a psychological phenomenon where people heavily weight their judgment of an experience based on the final outcome – even if they enjoyed the vast majority of an experience, if it ends badly, the memory is sour. There is data online about how long a game takes – make sure you know what you’re getting into and that it’s worth the opportunity cost. Beware the diminishing marginal utility of 100% completion of anything and embrace refund policies that will give you your money back after a couple of hours – that way, you’ll be incentivized to make a determination relatively quickly whether you’re actually enjoying what you’re doing.
    3. Schedule your digital entertainment in advance. Newport suggests that if you calendar when you are going to be able to take advantage of your vice, you will have an easier time resisting during the non-calendared time. You aren’t giving it up entirely, you’re just postponing it till after you complete this project, until the weekend, or whatever. 
    4. Put away your toys. The Make Time authors suggest that when you are done browsing or gaming, make sure to exit out of everything so that when you come back to your computer, you are starting clear (or, even better, with precisely the work you need opened up).
    5. Apply your skill points to real life. Consider the magical prospect that rather than dispatching your Sim to learn cooking, you could learn to cook for yourself. Or, rather than sniping that Nazi, you could genuinely master a rifle at the local firing range. As you contemplate customizing the character that is you, particularly bear in mind your social needs: join a paintball league for the adrenaline rush, break out the Risk board to think through strategy, or take on improv to flex your creativity.
    6. Enforce your schedule. It’s one thing to say that you won’t check a website until your project is done or that you will stop playing a game at your normal bedtime. It’s another thing to do it. Get creative in how to throw up obstacles: Use an app to block websites. Plug your computer or your Wifi into a cheap timer outlet that will cut off electricity at a certain time. Create a child account on your PC, put all your games on it, and enforce time limits with another complicated password difficult to retrieve. Don’t charge your controller so that the battery runs out. Lock your laptop physically in a cabinet. If you still press forward but at some point hit a speed bump or realize that you’re stretching yourself beyond your intention, hit the brakes, walk outside for a bit, and just think. Ultimately, embrace sunk cost, forgive yourself, and learn from the experience.
    7. Downgrade your computer. If you routinely overcome your obstacles to access the capability of your computer, eliminate the capability. Cancel your home internet. Get rid of your computer speakers. Get a computer with a bad graphics card and basic functionality. My own view is that the internet is an opportunity for such benefit that its harms aren’t worth the cut off – but you have to weigh the trade off in your own life.
    coffin

    Figure 4. The real 100% completion. How you play determines your Epilogue. 

     

    For your television:

    beware the relatively steep cost to benefit ratio.

    1. Consider alternatives to TV’s perceived value. Stress relief is better achieved through the activities described above by the American Psychological Association – where playing a sport is better than watching one (especially if your team is losing) or socializing with your own family is better than watching a family sitcom. Learning is best achieved through reading, itself a stress relief, but I’ve found that podcasts are a perfect substitute for something to have on in the background while you cook or do something else. 
    2. Only watch with family or while exercising. Make the most of your watching by only doing it when you can combine it with something good. TV has perhaps the best capability of any digital offering to be a shared simultaneous experience – I have always loved watching movies with my dad and we still watch old action flicks together over Christmas. Just be careful not to use this as an excuse to endlessly engage in TV at the expense of other shared experiences – or better conversations. Similarly, if you’re seeking to multitask, consider upgrading the background noise to podcasts. 
    3. Disable autoplay and prefer media with quicker ends. Go onto your streaming settings and disable the service from just queuing up your next thing to watch as soon as you finish the previous item. You want to choose when to continue based on your priorities. Similarly, movies outside the Marvel Universe are inherently going to be easier to manage than TV shows, which can easily dwindle in quality over the many hours you spend feeling a need to see how it all works out. Don’t forget the phenomenon discussed with gaming where a bad ending can sour the memory of an otherwise enjoyable experience (see, most recently, Game of Thrones). If you do find yourself engrossed in a deteriorating TV show, embrace sunk cost and quit!
    4. Cut cable, unsubscribe from streaming, and choose quality on demand. Per Make Time, switch your mindset from “What’s on?” to “There’s something specific I want to watch.” Get rid of your opportunity to surf endlessly for options to watch without friction and switch to a model where you purchase or rent each individual item. (I have mentioned before that the Netflix DVD service is still around and serves this purpose nicely.) Given the big benefits of non-screen alternatives, insist on only watching things you have high confidence in being good (such as over an 8 on IMDB, for example). 
    5. Hide the remote and its batteries in separate locations from your TV. Make it a chore to go find everything. Plug the TV into a cheap timer so it goes off before it endangers your sleep. And, if you haven’t already, change the passwords on your apps and delete them from your devices.
    6. Get rid of your TV. When you contemplate the balance between opportunities and harms of your smart phone or your computer, getting rid of them entirely is a hard argument to make – even dumbing them down by dramatically reducing their capabilities has problematic side effects that make the lesser measures more attractive. But when you apply the question to television, the benefits seem considerably more sparse. At the end of the day, most people, despite their protests, would probably be happier without a television. Giving up the gigantic opportunities associated with the internet is a big deal. Giving up TV just eliminates one form of entertainment – and, as we noted, some of the least effective strategies for stress relief. But if you can’t go to a friend’s to catch Stanford football, then the Make Time guys have a solution: replace your TV with a projector and a fold up projection screen. It’s a hassle. And that’s the point.
    Marathon

    Figure 5. Asked afterward the secret to his remarkable endurance, the first-time contender exclaimed, “I was just trying to get to the end of Lost!

     

    That about sums up what I consider some of the best takes on personal digital restraint. But perhaps your worries extend beyond yourself: what about kids?

    I don’t have personal experience as a father, but several parents have recommended Andy Crouch’s book on the Tech-Wise Family. I found it to be an excellent meditation as he explains his family’s approach (and how well they’ve lived up to their own rules, among them: zero screens for kids until they turn 10.) Crouch fears that “We most often give our children screens not to make their lives easier but to make our lives easier” and yet considers this a paradox because “the less we rely on screens to occupy and entertain our children, the more they become capable of occupying and entertaining themselves.” He also powerfully rejects the common defense “that children need to become ‘computer literate,’ as if learning to use computers were somehow as difficult and rewarding as learning to read itself.” After all, “A three-year-old (or a ninety-three-year-old) can intuitively figure out how to use an iPad. There is almost nothing to teach, and certainly nothing that any typical person can’t learn with a few hours of practice.” If you are raising a family, check it out.

    Bill Gates

    Figure 6. Bill Gates often ruefully reflects on a childhood deprived of such essential technology literacy builders as Fortnight and Snapchat.

     

    I’ll close by noting that some of the digital restraint authors I’ve cited believe that the responsibility for digital restraint goes beyond individuals managing their own use. Tristan Harris, for example, has called for vigorous antitrust actions against and taxation of big tech. But fellow Google alum James Williams, the author of Stand Out of Our Light, is interested in a steering wheel, not a brake and calls for the industry to self-regulate through individual tech workers taking  an equivalent of the Hippocratic Oath: 

    “As someone who shapes the lives of others, I promise to: Care genuinely about their success; Understand their intentions, goals, and values as completely as possible; Align my projects and actions with their intentions, goals, and values; Respect their dignity, attention, and freedom, and never use their own weaknesses against them; Measure the full effect of my projects on their lives, and not just those effects that are important to me; Communicate clearly, honestly, and frequently my intentions and methods; and Promote their ability to direct their own lives by encouraging reflection on their own values, goals, and intentions.”

    My advice: don’t wait on Silicon Valley or DC. Embrace the cascade(s) most relevant to your own goals of digital restraint!

    Tech wise family

    Figure 7.  Click here to buy the Tech-Wise Family (9/10), as much a meditation on family as tech, or here to buy Make Time (7/10), a breezy, cheery, practical book with some interesting ideas about how to get things done, especially with respect to digital distraction.

    Figure 8. Click here to buy Deep Work, 10/10 or Digital Minimalism, 7/10, both by Cal Newport.

    Willpower Instinct

    Figure 9. Click here to buy the Willpower Instinct (10/10) or here to buy Atomic Habits (8/10) – both great books I’ve reviewed before that apply generally to doing what you set out to do.  

    Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend:  know anyone who you’d like to spend more time with you than their devices? How about any parents? Or anyone who owns a wireless mobile device?

    I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

      Get Rich Slow

      The Gist: An exploration of an investor’s most important decision – how much to put where.

      A review of multiple books, most notably William Bernstein’s Four Pillars of Investing

      For a prerequisite tribute to index funds, check out my review Who Wants to Be a Millionaire?

       

       

      In our last correspondence, we explored the dismal and costly track record of both individual and professional investors compared to the lazier but more classically profitable strategy of slowly and continuously buying, holding, and balancing a diverse combination of low-cost index funds that return the historically generous market average. 

      So why doesn’t everyone just invest in indexes? The answer is an ironic combination of boredom and terror.

      little league

      Figure 1. It’s basically playing right field in Little League and somehow as a result getting more ice cream on average than your fellow players.

       

      When people normally put money toward investments, investing in a broad-based index just seems dull compared to the excitement of improbably picking a winner. Why buy small parts of 500 companies if your uncle was just telling you about a great article describing the sure-thing prospects of Whizbang Tectonics? William Bernstein playfully created “‘investment entertainment pricing theory’ (INEPT), which describes this phenomenon. For each bit of excitement you derive from an investment, you lose a compensatory amount of return. For example, a theater ticket may be thought of as a security with a high entertainment value and a zero investment return.” Of course, the theater can be pretty humdrum, too. Keep your asset allocation boringly profitable and get your excitement from swimming with sharks, joining a biker gang, and going over Niagara in a barrel to mimic the trajectory of your hand-chosen portfolio. 

      On the flipside, during a crisis, people lose their nerve as they watch their portfolio lose 20% of its value overnight. Why not sell before it gets worse and you’re wiped out? Historically, millions of investors who thought they could withstand risk sold at precisely the time that they should have been holding – if not buying. Still, if such a prospect freaks you out, the good news is that you can still structure your index investments to reduce risk – but understand that there is a fundamental relationship between risk and return. As Ben Graham intoned, “The investor’s chief problem – and even his worst enemy – is likely to be himself.” Bernstein relates a specific example:

      Myopic risk aversion—our tendency to focus on short-term losses—is one of the most corrosive psychological phenomena experienced by the investor. It is best demonstrated by this apocryphal story: An investor places $10,000 in a mutual fund in the mid-1970s and then forgets about it. Shocked by the October 19, 1987, market crash, she panics and calls the fund company to inquire about the state of her account. “I’m sorry madam, but the value of your fund holdings has fallen to $179,623.”

      william wallace

      Figure 2. To quote William Wallace: “Hoooooooold….. Hooooooold…. ”

       

      But what if we’re not talking a 20% loss, but 80%? Let’s look at 1929. Before getting to the misery, Bernstein notes that the stock market ‘bubble’ wasn’t entirely unreasonable: “Between 1920 and 1929, real GDP rose almost 50%… by today’s standards, stocks were positively cheap. Until 1928, they sold at approximately ten times earnings and yielded about 5% in dividends. Even at the peak, in the summer of 1929, stocks fetched just 20 times earnings, and dividends fell only to 3%. Again, tame by today’s standards.” Malkiel suggests that the principal problems were people borrowing to buy and the Fed’s ineptitude in first attempting to punish those borrowers, then in mishandling the consequences. Bernstein surveys the subsequent agony: “from the market peak in September 1929 to the bottom in July 1932, the market lost an astonishing 83% of its value. The loss was mitigated, however, by the approximate 20% fall in consumer prices that occurred during the period. The market recovered strongly after 1932, but in 1937, another drop of about 50% occurred.” Collins brutally notes that “should you have been unlucky enough to have invested at the peak, your portfolio wouldn’t have fully recovered until the mid-1950s, 26 years later.” 

      By now, your instinct for loss aversion is up and you’re ready to split your assets between cash and collectible knick knacks that you can at least enjoy looking at. But Collins points out that you would have had to have been incredibly unlucky to invest everything at the peak. If, instead, you had been investing steadily from your paycheck, your investments from 1926 and 1927 – midway up the stock market rise – would have been positive within 10 years. Indeed, the Bogleheads reveal that “Over the 85-year period from 1929 through 2013, we can clearly see that an investor who picked the worst one-year period to invest in large domestic stocks would have lost 43 percent. However, the same investment over any 10-year period would have lost only 1 percent.”

      10 years! Who has a decade to spare for a measly return? In some ways, riding out a crash is easier than long periods of slow growth. Bernstein reveals that “an examination of historical stock returns shows that the market can perform miserably for periods as long as 15 to 20 years. For example, during the 17 years from 1966 to 1982, stock returns just barely kept up with inflation.” Retirees with too much stock exposure certainly suffered. But this long era of malaise was absolutely stupendous for anyone working throughout, diligently investing a portion of their paycheck. Warren Buffett asks a couple of questions to get at the principle: “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?…  If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?” Malkiel analyzes: “Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying. This reaction makes no sense.”

      bernie sanders

      Figure 3. Thus explains the youth appeal of Bernie Sanders?

       

      Continuously investing in a bear market takes a lot of grit – how certain can you be that the market eventually will recover? You can’t. That’s why so many people stop buying or sell. Again, there is a fundamental relationship between risk and return. As a historical matter, we can observe that this has been the right strategy in the United States again and again as the long term trajectory of our markets has been a glorious up. But this is subject to hindsight and survivor bias. Every great nation of history had a good run until they didn’t. Turn on a TV and you can start worrying that our screwing up our historic ingredients for success is unfortunately quite plausible. Bernstein worries: “Until World War I shut down the St. Petersburg exchange in 1914, the Russian stock and bond markets were among the world’s most respected and active. They never reopened. During the twentieth century alone, military and political upheaval rendered not just St. Petersburg’s bourse, but also many other once-vigorous securities markets, defunct, or at least moribund: Cairo, Bombay, Buenos Aires, and Shanghai, to name a few.” Malkiel lucidly talks through the incredible speculative run-up of the Japanese stock market, where “stock prices increased 100-fold from 1955 to 1990.” At one point, the grounds of the Tokyo Imperial Palace – sitting on only half of a square mile – were valued greater than all of the real estate in California. Japanese investors at the height of the bubble have still not recovered 30 years later. 

      All of which brings us to your single most important decision as an investor: how you will allocate your capital among different asset classes. To get a sense of how important this is, the Bogleheads point to a major study of 91 pension funds’ investing over a decade that found that the differences in what percentage they put into each asset class accounted for 93.6% of the difference in performance between them. The final 6.4% was split between the time they bought and sold, the individual securities they selected, and the costs they were charged. To reinforce an earlier point, the same study also found that attempts to actively manage the fund – as opposed to leaving things in relevant indexes – cost pensions 1.1% in performance. 

      As you make your decisions, keep in mind a few things. First, invest only in things you understand well enough to explain to a 12 year old. Your money is at stake and good returns don’t require complexity – in fact, they may be better correlated with simplicity. Second, make sure your asset allocation reflects your desired risk. In chasing better returns, realize you are inherently going to be in riskier investments that could have, at the very least, more volatility. If your blood pressure can’t handle big swings, go for a safer, simpler allocation. If ultimately this gets too complicated and you want to set it and forget it, you can invest in low cost funds that diversify for you, either based on your target retirement age or your target risk. Third, for proper diversification, the Bogleheads advise “You want some investments that zig while others zag.” To protect yourself at various times, you are going to want asset classes whose performance is not directly correlated with each other. That might mean that certain aspects of your portfolio lag for a long time – and that’s not really a bad thing if you’re confident in their fundamentals. Focus on total portfolio performance. Fourth, be hyper-vigilant about fees and taxes so that you can capture most of the benefit of your returns. The further you drift from a broad market index, the more certain fees you may end up paying for uncertain performance. At the same time, some asset classes or indexes are inherently more or less tax efficient than others. Your tax inefficient holdings are ideally placed in a 401(k) or Roth IRA. I don’t have space to get into all the details, but you absolutely should research your eligibility for them (and precisely what costs and fees are involved).

      fortnite

      Figure 4. For the typical 12 year old, you’ll have to properly analogize. Like Fortnite, the winner of investing is the one who manages to hold on while everyone is dropping out. Of course, given the preteen popularity of TikTok, you might have trouble explaining the riskiness of Emerging Market indexes.

       

      The biggest asset allocation question you have to answer is what percentage of your investments to own in bonds versus stocks. In case these terms require demystification: when you buy a bond, you are loaning money to a company or government that they promise to pay back with regular interest. It’s nice to be owed by these guys for a change – and, generally, bonds are considered safer than stocks, especially over a short term, but, predictably, they bring less return. When you buy a stock, you are literally buying a small percentage of a company. Congratulations – you are a business owner!

      Bonds tend to face three problems: first, inflation endangers the value of your return. Second, many bonds are callable, so that if interest rates decrease, the lendee will simply borrow somewhere else and pay off the expensive bond. Third, the lendee may default. An index of bonds broadens your exposure and thereby limits your risk – but you might consider buying U.S. Treasuries directly because you can do so online without a broker or ongoing expenses. Bernstein cites Jeremy Siegel’s Stocks for the Long Run: “stocks outperformed bonds in only 61% of the years after 1802, but that they bested bonds in 80% of ten-year periods and in 99% of 30-year periods” Further,  Malkiel shares that, most recently, “bonds have produced average returns of 7.1 percent versus stock returns of 11.4 percent over the 50-year period ending in 2016,” but importantly, they zig when stocks zag: “bonds proved to be excellent diversifiers with low or negative correlation with common stocks from 1980 through 2018” Ultimately, Bernstein says “we own stocks to hedge long-term risk and bonds to hedge short-term risk.”

      shark

      Figure 5. As you buy bonds, it’s fun to think of yourself as a corporate loan shark. “Nice car you got there, Tesla. Shame if something happened to it after you defaulted.”

       

      The classic rule of thumb is that the percentage of bonds in your portfolio should be your age – that way, your portfolio becomes less risky as you approach retirement. Several authors believe that this is too conservative for investors with full-time jobs and that their bond percentage should max out at 20% or 25% until they approach retirement. Bogle, bullish on stocks, had an approximately 80% stock/20% bond mix into his 90s, advised young investors to flirt with 100% stocks, and thought retirees would do fine with a 50-50 ratio. Bernstein, on the other hand, suggests that younger investors might want a larger percentage of bonds until they’ve lived through at least one crash and understand how they’ll react. While Bernstein believes a disciplined buy and hold of more stocks would be better over time, a bigger percentage of bonds that made investors feel safe in a crisis would be better than selling off stocks in a panic. Indeed, he notes, a stock crash would generally be a good time to sell bonds and buy stocks. And Bernstein is also skeptical of the size of the recent return premium stocks have had over bonds, so that at least 20% in bonds is always valuable. Similarly, the legendary Ben Graham suggested that you should never have more than 75% in either allocation, and the data over the last 100 years suggest that those are good upper/lower limits for risk/reward ratios. Ultimately, the perfect portfolio is only clear in retrospect – you need to decide this for yourself.

      Once you’ve settled on what percentage of bonds, you’ll have to determine what kind. For simplicity, the indexers tend to prefer a total bond market index for tax-protected accounts and a total municipal bond market index for taxed accounts (the latter is free of taxes, but has predictably lower returns). There’s a richer debate about the duration of your bonds. Longer-term bonds pay more because there’s less certainty about the distant future’s inflation and default rates. Bernstein warns “Long-duration bonds are generally a sucker’s bet – they are quite volatile, extremely vulnerable to the ravages of inflation, and have low long-term returns.” He suggests the average duration of your bond should be less than 5 years – after all, your bonds are the short-term hedge. The Bogleheads, on the other hand, recommend choosing a timeframe that matches your need: if you are going to need the cash in 2 years, go for short term. If you’re investing forever, buy the total index. Relatedly, Malkiel likes zero-coupon bonds – an instrument that you buy at a discount, pays zero interest, but gives you the full amount at a time you specify (i.e. for paying for college). Junk bonds promise high yields because the lendees are of questionable ability to pay – all the indexers avoid them because they prefer safety in bonds and risk in stocks. There’s also some appeal for a particular type of U.S. bond that explicitly promises to pay a return above inflation – that takes care of a significant concern – but this type of bond is considered so safe that it tends to have little return and, worse, it’s taxable.

      trashcan

      Figure 6. Your new nickname for your brother-in-law can be “Junk Bond”

       

      Once you’ve settled on your allocation within bonds, you’ll move to stocks. Here, you’ll want to determine whether you want a simple portfolio that covers the total market in proportion to individual companies’ size – or whether you want to flavor your portfolio with exposure to different elements of the global marketplace, usually at greater cost and risk for certainly more diversification and complication, possibly more return.

      A major question is how much you should invest in the United States versus overseas. Bogle was essentially an investing nationalist: when you invest internationally, you are being exposed to multiple additional risks beyond company performance, including different accounting standards, political trouble, and currency differences. If you simply invest in the S&P 500, those American-based companies already get half their revenue from abroad which could be enough international exposure for you. Finally, investing globally can involve more fees than investing at home. On the other hand, Malkiel reminds us that the United States represents less than half of the global investing economy and Bernstein suggests that the number of differences between the United States and elsewhere mean that international stocks zig while domestic stocks zag – exactly what you may be looking for in a diversified portfolio. And, returning to our Japanese or Russian examples, Bernstein insists the takeaway is not that international markets are scarier, but that markets anywhere, including here in the United States, are subject to unexpected risk, so avoid excess concentration.

      If you do decide to invest internationally, you can simply buy an index that covers the world, as the Bogleheads simply advise, or you can break it down into indexes of particular regions or economic development. There’s always a danger the more specifically you index the closer you are approaching historically-fraught stock-picking. But there are reasons to consider breaking it down: first, owning the equivalent of the S&P 500 for Europe is relatively low cost and tax-efficient and so may be more appropriate for a taxable account. You still get the zig: Malkiel notes that from 1970 to 2017, an index of international developed economies’ stocks has done equivalent to the S&P but have only had a 0.5 correlation. Second, if you own the whole international market, you may be over-exposed to regional bubbles, such as with Japan in the late 1980s dominating the international index. Third, you may want to manage your exposure to faster-growing emerging markets. Malkiel is intrigued by their growth and notes their better performance than developed economies from 2000-2010. Bernstein thinks that there are substantial gains to be made in the very long transition from a riskier, emerging economy to a developed economy – but that those don’t always translate into immediate stock market returns – “China has had one of the world’s highest economic growth rates—at times exceeding 10% per year—yet between 1993 and 2008, its stock market lost 3.31% per year. The same is true, to a lesser extent, for markets in the Asian ‘tigers’ (Korea, Singapore, Malaysia, Indonesia, Taiwan, and Thailand), which since 1988 have all had lower returns than those in the low-growth United States.” Again, ultimately, you’ll need to decide for yourself. Within the books reviewed here, the range of recommendations for how much international stock to own is 0 – 30% of your total portfolio.

      Kings

      Figure 7. Sadly, you’ll have to forgo the most promising foreign investments in emails from Nigerian princes.

       

      Of course, the core of your stocks should be within the United States, where you can easily invest in an index that covers most of the stock market. For simplicity’s sake, once you’ve settled the bond and international questions, you could stop right there. Bogle’s personal portfolio had the beauty of simplicity: 80% S&P 500, 20% total bond market index. And, indeed, all of the indexers covered here tend to recommend putting at least a plurality of your stocks into the S&P 500 or the total US market. As mentioned before, there’s always a danger the more specifically you index the closer you are approaching historically-fraught stock-picking. But if you want to get creative, there are advocates for indexes of two sectors in particular (real estate and precious metals), the smaller companies in the market (small-cap), and companies that are trading at a relatively smaller multiple of their earnings or net worth (value) – but note that practically everything is going to have higher costs than a broad market index.

      Most indexers believe that real estate is a good investment because it has had similar returns to the generous stock market over time while not being exactly correlated. The principal vehicle that people use to invest in real estate is a real estate investment trust (REIT) – and they have some peculiarities, chief among them that they have to distribute 90% of their profits in dividends, which are not ideal in a taxable account. That distribution feature also means that they heavily rely on debt for expansion, which creates its own risk. Publicly traded REITs also, for better or worse, own only a single digit percentage of the total U.S. investable real estate market, so they are not as broad an investment as desirable. There are other opportunities to invest in real estate outside indexes, but whatever you do, do not consider your personal home an investment. The authors reviewed here are otherwise skeptical of sector indexes because they feel too close to stock-picking and they fear being that rational investor in 1900 who, looking for an evergreen industry, invests in a blacksmith index. But at least Bernstein likes a very small exposure to precious metal stocks as one industry that persistently zags. While uncorrelated, the precious metals sector may primarily be an inflation hedge, and there may be better alternatives over a long time.

      cigarettes

      Figure 8. If you’re seeking to design a post-apocalyptic portfolio, conventional securities aren’t going to be that useful – Mad Max isn’t likely to value the printout of your Charles Schwab holdings in gold mining companies. Instead, carefully allocate to bullets, alcohol, and cigarettes – the latter two being all the more valuable if you’re not a personal consumer!

       

      The theoretical appeal of small companies in the bottom 10% or so of the market is that, by their very size, they may have an easier route to greater returns. They also, of course, are closer to going out of business. Bernstein points out that “the small stock advantage is extremely tenuous—it’s less than a percent-and-a-half per year, and there have been periods of more than 30 years when large stocks have bested small stocks.” An index of small cap companies spreads your risk – but anytime a company is too successful, they get bigger, prompting the index to sell the shares in a taxable event. And, naturally, keeping track of these smaller companies means more fees than a broad based index. Malkiel also cautions that small cap companies may now have become too popular (and therefore overpriced) even while there’s relatively little analyst attention to this small part of the market. Malkiel further points to data that “single factor funds have either produced returns that are roughly equivalent to broad-based index funds or their returns have been inferior” – but that may again go to the question of correlation. 

      The theoretical appeal of value companies trading at about the lower third of multiple of book value is that you can buy them cheap and they are less subject to speculative bubbles. In any given decade, investors will get enthusiastic about a particular industry or country or whatever and they’ll feverishly bid up prices to be a gigantic multiple of the earnings and value of a company in anticipation that “some greater fool” will pay them more for it. There may, of course, be a good reason why a company is trading at a lower multiple. Yet Bernstein reports: “There have been a large number of studies of the growth-versus-value question in many nations over long periods of time. They all show the same thing: unglamorous, unsafe value stocks with poor earnings have higher returns than glamorous growth stocks with good earnings.” Nevertheless, like a small cap index, if a company does start to trade at a higher multiple, it will get sold – and create another taxable event. Targeted value indexes have more expensive fees than the broad market index – and they can underperform that broad market index for over a decade. I’ll repeat Malkiel’s warning about single factor funds – but I’ll also note that he’s more intrigued by multiple factor funds, like combining the two we just discussed for a small cap value index (and more fees and taxes!). For what it’s worth, Richard Ferri reports that “According to researchers Gene Fama and Ken French, 95 percent of the return on a widely diversified U.S. stock portfolio can be explained by that portfolio’s market risk (beta), percentage in small stocks (size risk), and percentage in high book-to-market stocks (value risk). Over the long term, U.S. small-cap stocks have achieved a return premium over large-cap stocks, and value stocks have achieved a return premium over growth stocks.”

      bubbles

      Figure 9. Value stocks help you miss getting hosed in the financial bubble bath

       

      Once you’ve determined your ideal allocation, you have one final decision to make: whether, when, and how to balance your account. The different aspects of your portfolio will be growing at different rates and so the perfect allocation you originally conjured will eventually be out of whack, such that your 60% stocks is now 80% due to a bull market. Bogle believed that the unbalanced portfolio was “likely to provide higher long-term returns” because you let your winners ride and just adding more money without selling anything means you will be less likely to dangerously tinker. Bernstein cites lots of academic evidence to argue the opposite, that rebalancing will generally lead to higher returns, though “usually no greater than 1 percent per year.” Bernstein’s argument is premised on reversion to the mean – you want to sell winners because they are probably overperforming relative to their base rate and, relatedly, the losers are cheap underperformers. In this vein, Bernstein insists: “Do not allow the inevitable small pockets of disaster in your portfolio to upset you. In order to obtain the full market return of any asset class, you must be willing to keep it after its price has dramatically fallen. If you cannot hold onto the asset class mutts in your portfolio, you will fail. The portfolio’s the thing; ignore the performance of its components as much as you can.” Of course, if all your investments are in a taxable account, then selling winners will lead to capital events whose taxes will overwhelm the real but limited gains. Nevertheless, Bernstein argues that you would still want to rebalance occasionally in a taxable account to reflect your risk tolerance, either because you are getting older and want more security or, as in the example above, stocks have run up in a big bull market and you want to preserve some of your gains.

      If you decide to rebalance, you need to decide when and how. For when, Bernstein suggests that the best answer may be every few years and, additionally, if there’s a big swing (20%?) in market prices. The Bogleheads, appropriately sensitive to taxes, recommend selling losers before year’s end and winners in the new year to take advantage of something called “tax loss harvesting.” For other tax reasons, they cite a Morningstar study that suggests rebalancing should not be done more frequently than every 18 months. I’ll also remind you that there are low cost funds that rebalance for you, either based on your target retirement age or your target risk. For how, you can obviously sell the over-performers and buy the under-performers. But in an ideal world, you’re putting money in the market every month or quarter and you can use that to try to bring things back into your preferred percentages, such that if stocks are out of whack, your monthly contribution may only go toward bonds. The key here is putting in about the same every time as opposed to waiting for when prices are low: time in the market beats timing the market. Malkiel cites a University of Michigan study that found that “95 percent of the significant market gains over a thirty-year period came on 90 of the roughly 7,500 trading days. If you happened to miss those 90 days, just over 1 percent of the total, the generous long-run stock-market returns of the period would have been wiped out.” And Malkiel piles on by citing Laszlo Birinyi: “a buy-and-hold investor would have seen one dollar invested in the Dow Jones Industrial Average in 1900 grow to $290 by the start of 2013. Had that investor missed the best five days each year, however, that dollar investment would have been worth less than a penny in 2013.”

      If you’ve gotten this far, that’s about it. Invest regularly, and only in things you truly understand. Make sure your asset allocation reflects your desired risk – and remember chasing more returns means risking bigger losses. Diversify within assets with indexes and across assets through allocation and rebalancing. Be hyper-vigilant about fees and taxes so you can capture most of the benefits of your returns. And, as Malkiel advises, be patient and disciplined: “You can only get poor quickly. To get rich, you will have to do it slowly, and you have to start now.”

      Four pillars of investing

      Figure 10. Click here to buy William Bernstein’s Four Pillars of Investing, 9/10. As a reminder, the four pillars that you must understand are the theory of investing, the history of markets, your own psychology, and the adverse interests of the investing business – which includes financial journalism! Bernstein recommends that you avoid the media, filled with English-major journalists currying favor with those they cover, and instead read books like the ones reviewed here. Bernstein best articulates the real risk that comes with investing and why it’s important to diversify. For better or worse, he is an asset-class junkie who suggests an ideal portfolio that is more complicated than others covered here (and he gives more specific advice about investors in different situations). But despite his worries, he still sees a longer trend up for stocks:

      A superb metaphor for the long-term/short-term dichotomy in stock returns comes from Ralph Wanger, the witty and incisive principal of the Acorn Funds. He likens the market to an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the market players, big and small, seem to have their eye on the dog, and not the owner.

      A random walk down wall street

      Figure 11. Click here to buy Burton Malkiel’s classic A Random Walk Down Wall Street, 8/10. Though first published decades ago, Malkiel has continuously and freshly updated it to reflect the latest data and events. Malkiel explicitly addresses one major recent concern about index funds: that they’ve gotten too big and that there will soon not be enough actors in the market to price things correctly. Malkiel essentially responds that the temptation of inefficiency will be too great for some not to take advantage of it. Appreciated his quoting J Kenfield Morley: “In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well”

      bogleheads guide to investing

      Figure 12. Click here to buy the Bogleheads’ Guide to Investing, 9/10. A very practical and simple overview that goes deep into what it means to follow the path laid down by John Bogle. Amusing citation of Gene Brown: “Foolproof systems don’t take into account the ingenuity of fools”

      little book of common sense investing

      Figure 13. Click here to buy American investing hero John Bogle’s Little Book of Common Sense Investing, which lives up to its title and is a stirring call to arms, based on law of averages, for investors to humble themselves by picking the cheap indexes that outperform all the hard work of expensive active managers.  8/10. Has a great quote from Buffett: “The greatest Enemies of the Equity investor are Expenses and Emotions”

      Simple Path to wealth

      Figure 14. Click here to buy JL Collins’ The Simple Path to Wealth, 7/10. The premise of this book was investing advice that the author wanted to pass along to his daughter and it’s an easy read, but probably should be read in conjunction with the Four Pillars to ensure you have a proper sense of risk. Collins does a great job illustrating how the Great Depression was bad, but not as bad as you might think – but overall is perhaps more optimistic than warranted about stocks. Perhaps a better case is made by Jeremy Siegel in Stocks for the Long Run who argues that peak investors before the Great Depression actually recovered faster than Collins suggests (15 years v. 26) and, what’s more, “since World War II, the recovery period for stocks has been even better. Even including the recent financial crisis, which saw the worst bear market since the 1930s, the longest it has ever taken an investor to recover an original investment in the stock market (including reinvested dividends) was the five-year, eight-month period from August 2000 through April 2006.”

      Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: Know anyone who wants to know more about investing? How about anybody who wants to be rich? Or anyone who would like to avoid becoming poor?

      I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!