One More "Don't Buy This Book" from Bill Bernstein

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nisiprius » Sat Aug 31, 2013 5:37 pm

For me, the elephant in the room is the question of why we should assume that the stock market is the same thing and has even the same quantitative statistical behavior as it did X years ago. At some point, it just become ludicrous. Dr. Bernstein can probably fill the history in better than I can, but, let's sketch it out.

Before 1890 or so, most serious industrial financing is through bonds. Stocks are some weird speculative sideshow.

Before 1920 or so, there is no serious retail participation in the stock market. Then people like John Jakob Raskob realize there is serious money to be made from the participation of the general public, companies split stocks prices down to make them affordable, and stock investing becomes a craze like crossword puzzles.

Before the SEC, manipulation is what the stock market is about. "Bulls" and "bears" aren't people who hope the stock market will go up or down, they are people who hope to make the stock market go up or down. The question isn't whether the market can remain irrational whether than you can stay solvent, it's whether one syndicate or another can remain solvent longer than another. The question isn't how much thus-and-such corporation is going to pay in dividends, it's who's behind this syndicate and how much money do they have?

The Investment Act of 1940 creates the legal and regulatory structure of mutual funds as we know them.

The end of fixed commissions produces a qualitative change in the cost of trading and what kinds of investing strategies become feasible for the retail investor.

The creation of the 401(k) brings retirement savers into the market on a scale never previously seen.

Electronic data processing, networks, etc.--why shouldn't these have changed the fundamental dynamics of the market as much as radio changed the fundamental dynamics of governing?

Etc. etc. etc.

Maybe the economists can prove that the fundamental things apply as time goes by, but has anyone even claimed they could derive "Siegel's Constant" from economic modeling? Siegel himself says that it is a purely empirical observation. Is there any reason why the Erie Canal's real return should be the same as Facebook's?
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Blue » Sat Aug 31, 2013 6:27 pm

wbern wrote:I'm of two minds about a low-rate fixed mortgage. On the one hand, it's always nice to burn the mortgage. On the other hand, if we ever get high inflation, a 4% mortgage is going to look mighty good to you.

Bill


Why doesn't the larger cash hoard requirement of having a mortgage (vs smaller cash hoard requirement without mortgage and thus larger stock portfolio) offset any inflationary protection of having a fixed rate mortgage?

Thanks in advance,
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Bill Bernstein » Sat Aug 31, 2013 8:40 pm

Bob:

Your points are well taken; we'll never have the "complete" series. Nonetheless, the 20th century was pretty wild, and I doubt that short of total planetary anihilation, there are not too many things that the future can throw at an individual national market that the 20th didn't; there's just not a lot of territory outside that bounded by complete disappearance (communist nations) on the downside and a tripling over one century of the P/D ratio on the upside (the "optimists who triumphed"). I consider it pretty unlikely that over a long enough period it's possible for nominal bonds to beat stocks for both theoretical and practical reasons. Impossible, no. But darned unlikely.

I specifically excluded TIPS from my "stock/bond" dichotomy, and recommend them strongly for inflation protection. For example, a number of European nations, including Weimar Germany, issued gold-backed bonds, and they did well.

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Browser » Sat Aug 31, 2013 9:16 pm

I keep recalling that despite what we think we have discovered about how markets have worked in the past, even if we actually do understand it pretty well, and even if markets have already experienced a significant sample of what can be thrown at them, at the end of the day how you and I will fare is probably based more on dumb luck than what we know and what we do. Luck just doesn't get enough credit. After all, an individual just has a little slice of time to be in the markets and try to survive. Just hope your slice is a good draw.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby bobcat2 » Sun Sep 01, 2013 10:24 am

In the long run stocks outperform fixed income securities.

At a convention in Geneva in 2004, Nobel Laureate Robert Merton told a joke which went roughly as follows.

An equity salesman for a major Wall Street firm called on a very conservative pension fund manager, who had invested 100% of the pension fund's assets in fixed income securities. The equity salesman told him, 'Why don't you shift your portfolio into common stock? In the long run, you'll have a 99% probability of having more money because your time horizon is so long.' The pension fund manager replied, 'Well, if you are right, your firm would find it very inexpensive to provide me with a portfolio insurance policy that will pay me the difference if ever in the distant future an all equity portfolio was worth less than my fixed income portfolio would be worth. Why don't you price that insurance policy with your colleagues and call me back? If it's as cheap as your argument indicates it should be, I am sure your firm will offer me that insurance policy very cheaply.

As the audience laughed, Merton added that the salesman never called back, because the risk of equity portfolio price declines is huge and such an insurance policy would be very expensive.

Consider the case of Japan. I think it is likely that the Japanese stock market will outperform the Japanese bond market over the 60 year period from the end of 1989 thru 2049, but I think it is hardly a sure thing.

More importantly I consider it a bit of red herring to consider a 60 year period. For most households saving and investing primarily for retirement and not legacy concerns, there is roughly a 30 year window for investing heavily in stocks. That window essentially extends from age 30 to age 60. Before age 30 they simply don't have enough assets to be heavily invested in stocks. After age 60 it is imprudent to be heavily invested in stocks, if the portfolio is being counted on to provide reliable retirement income. Certainly the window doesn't extend any where near age 90 and a 60 year investment horizon. And over 30 year investment horizons bonds can definitely outperform stocks some of the time.

None of this is to say you shouldn't invest in stocks. You will very likely get higher returns by investing in stocks, but those higher expected returns come with risk, and that risk is you could do worse. Stocks are a risky investment asset and a plain spoken definition of a risky asset is that it is one that can do very well or very poorly regardless of the time horizon.

Because of the higher expected returns stocks offer, I personally believe most people should invest a significant amount of their portfolio in stocks over at least some portion of their investment horizon. But they shouldn't invest in stocks in the belief that if they hold them long enough, they will become a safe investment relative to bonds.

Finally I think over extremely long investment horizons stocks are no more risky than bonds. Over periods of at least 130 years the worst outcome for stocks and bonds is that they both go to zero. So if you are a vampire and plan to retire 150 years from now, stocks are extremely unlikely to underperform bonds over your investment horizon. That, however, doesn't work so well for humans. :wink:

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nedsaid » Sun Sep 01, 2013 1:10 pm

I am reminded of the saying that in the long run, we all are dead.

Every investor needs to develop convictions and philosophies about the markets and investing that will carry them through the inevitable tough times. We have all developed assumptions about how markets work and what to expect. Without these, we would never have any type of coherent investment strategy.

Here are some of mine:

Invest in asset classes that show real return over long periods of time. You need to beat inflation.

Inflation is the biggest risk to investors. Even at 2%, it relentlessly chews away at your purchasing power. To beat inflation, you have to take market risk.

Stocks are a proxy for owning a share of the economy. You own shares of real businesses. You can expect your return over time to equal the growth in the economy plus your dividend yied.

Stocks beat bonds over long periods of time. More risk equals more return. Stocks are risky.

Boring is good. Boring that pays a dividend is even better.

Buy good stuff and keep it. Don't sell unless you have a darned good reason.

Don't chase returns and don't chase yields.

Bear markets are when you make money as an investor. It just doesn't feel that way.

I could go on. But you get the idea. The point is that when crafting a long term investment strategy, you start of with making certain assumptions and philosophies that you build the strategy on. Hopefully, you have research and history and a good knowledge of human nature to back these assumptions, convictions, and philosophies up.

This is why I have enjoyed this thread. It gets us to look at what is really behind the investment plans that we have constructed for ourselves. And it gets us to look so see the underpinnings of the Boglehead philosophy.

Thanks Dr. Bernstein for getting us all thinking. Thinking is good. Getting it all on paper is better. Dr. Bernstein is doing both.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby garlandwhizzer » Sun Sep 01, 2013 1:22 pm

nedsaid said
I am reminded of the saying that in the long run, we all are dead.

Every investor needs to develop convictions and philosophies about the markets and investing that will carry them through the inevitable tough times. We have all developed assumptions about how markets work and what to expect. Without these, we would never have any type of coherent investment strategy.

Here are some of mine:

Invest in asset classes that show real return over long periods of time. You need to beat inflation.

Inflation is the biggest risk to investors. Even at 2%, it relentlessly chews away at your purchasing power. To beat inflation, you have to take market risk.

Stocks are a proxy for owning a share of the economy. You own shares of real businesses. You can expect your return over time to equal the growth in the economy plus your dividend yied.

Stocks beat bonds over long periods of time. More risk equals more return. Stocks are risky.

Boring is good. Boring that pays a dividend is even better.

Buy good stuff and keep it. Don't sell unless you have a darned good reason.

Don't chase returns and don't chase yields.

Bear markets are when you make money as an investor. It just doesn't feel that way.


1+ Totally agree

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nedsaid » Sun Sep 01, 2013 1:29 pm

Wow Garland Whizzer, I appreciate the response.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby bobcat2 » Sun Sep 01, 2013 1:42 pm

Inflation is the biggest risk to investors. Even at 2%, it relentlessly chews away at your purchasing power. To beat inflation, you have to take market risk.

Has there been a time when LT real US bonds have had negative real yields? Where is the evidence that we can expect low risk real government bonds to typically have negative real returns?


Stocks beat bonds over long periods of time. More risk equals more return. Stocks are risky.

More risk does not equal more return. If more risk equaled more return - how would that be risk? More risk does mean more expected return. Unfortunately, expected return and return are not the same thing. Nominal bonds have outstripped stock returns for forty years or more in the capital markets of numerous countries since 1900. The capital markets of most countries have had 30 year periods where bond returns have been higher than stock returns since 1900.

Stocks are risky. In plain language, a risky asset like stocks is one that can do extremely well or extremely poorly regardless of the length of the investment horizon.

This isn't from my own investment philosophy. This all comes out of finance 101. :wink:

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nedsaid » Sun Sep 01, 2013 6:37 pm

Excuse me, long term government bonds are quite risky. No default risk but they fluctuate like crazy with interest rates. If you bought and held 30 year treasuries to maturity, no problem. Most of us that invest in fixed income do it through mutual funds and not the purchase of individual securities. So we are subject the the fluctuations of principal.

Whether long term government bonds beat inflation or not depends on the timing of the purchase of those bonds and the timing of the spurt of inflation. I suppose those who were holding 30 year treasuries bought in 1972 would have seen inflation exceed the yield on those bonds just a few years later. But you are correct that historically that long term government bonds beat inflation and by about 3%.

If we see an extended period of time during which interest rates go up, the long term bonds will do very poorly. I would rate the long term part of the market as quite risky at this time.

I would never recommend long term government bonds for an individual investor. A couple possible exceptions would be for an investor to wants to do a permanent portfolio like strategy and use long term government bonds as a deflation hedge. These instruments are the best deflation hedge I can imagine. Another exception would be to an investor who had a come heck or high water committment to holding these to maturity and collecting the interest.

What I would recommend to individual investors would be the intermediate term bonds where you get most of the yield but with a lot less risk. If you have years to retirement, you just reinvest the dividends. (A retiree or near retiree should think over the risks of principal fluctuation as they are or will be soon be drawing the dividends to live on).

I am also aware that stocks can have long periods of lousy performance. The industry likes to call these secular bear markets and they can last up to 20 years. This is why I think every investor should have a good helping a bonds in their portfolio and also why I like dividend stocks.

But after the 1929-1948 and 1968-1982 secular bear markets, we saw extraordinary bull markets. As of 2013, the market averages are barely over the year 2000 highs. No guarantees, but history suggests that better days are ahead for the US Stock Market. In any case, we have seen real returns of 6-7 percent versus 3 percent for long term treasuries.

I went to hear Jeff Auxier, a fund manager that runs a mutual fund and a small investment firm. He said that governments eventually all default on their debt obligations. There were only six examples of countries that had not. So government bonds are not as safe as perceived. And it could be argued that the US effectively defaulted on its debt by devaluing its currency either by changing the relationship of dollars to gold or going off the gold standard all together. (I am not advocating for a gold standard). Allowing inflation to run higher than normal could also be argued as a form of default. Government debt can be risky!! We just don't perceive the risks.

So when constructing an investment portfolio, there are no guarantees. Ultimately, any asset class we hold near and dear could fail. What we do is construct a portfolio tilting the odds in our favor as much as we can.

When the financial crisis hit and the stock market fell out of bed, I was scared like everyone else. I was too scared to rebalance but I did the next best thing. I redirected ALL of my new funds for investment to the US and International Stock markets. I didn't know the markets would bounce back. For all I knew, it could really have been financial armaggedon and the end of Western Civilization. But I knew that historically that the markets bounced back. Didn't know for sure but the odds were pretty darned good.

Thanks Bobcat2, I enjoy reading your posts and appreciate your comments.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby bobcat2 » Sun Sep 01, 2013 8:38 pm

Global real stock returns have been about 5% or slightly less, not 6% to 7% since 1900, which is a very long period. Here are the real annual mean geometric equity returns from 1900-2012.

Code: Select all
                   Annual real return
US                        6.3%
World                     5.0%
World exUS                4.4%


Source: Credit Suisse Global Investment Returns Yearbook 2013

Even in the US there can be long periods when real stock returns are significantly less than 7%. For example, over the most recent 50 year period (1963-2012) the real return on US stocks is 5.6%. Again the source is the Credit Suisse 2013 Global Yearbook. Remember that of all the stock markets in the world only the Australian equity market market has had better returns than the US market since 1900.

The yearbook is an annual update of the "Triumph of the Optimists" stock, bond, and bill return data for most global capital markets going back to 1900.

Since the stock markets not yet included in the global stock market data base will tend to be markets that failed one way or another, the 5% for the world and the 4.4% for the world exUS are slightly biased high estimates of returns. There are a couple of other technical reasons that that also make the world and world exUS slightly biased high. Taking all these biases into account would indicate that before any expenses or costs the global real return on equities has been about 4.5% to 4.8% from 1900-2012. Not 6% to 7%.

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nedsaid » Sun Sep 01, 2013 9:43 pm

BobK, I guess the US got a 1.9% performance premium from being on the winning side of WWI and WWII. It sure helps to win wars doesn't it?!

The 6-7% real returns I cited I have seen several different places. I know a lot depends on the time periods selected. I suppose the data from the 1920's and forward were different because for the first time, the public had interest in investing in the stock market. The data from 1934 and on would be different because of the securities regulation implemented by the Roosevelt administration. The government oversight gave the public more confidence to invest, that the markets weren't just a rigged game.

The figures I cited came from somewhere and didn't come out of thin air.

Below is a post from another thread that is reposted with comments. There was a comment on the thread that mentioned that certain country stock markets went to zero. So there were two questions that came up in my mind? First, did these markets actually turn worthless? Second, how did the markets in Germany and Japan respond to losing World War II? I cannot imagine a worse case scenario than losing WW2. I googled around and found a Motley fool article that addressed my questions.

I did find that the Japanese stock market losed near the end of WWIi and didn't reopen until almost four years later. I wonder what happened to the shares. Did they become worthless or did they merely stop trading? (Bob, do you have the answer to this? For example, Mitsibishi makes cars that many of us have driven. This same company made the famous Japanese Zero fighter plane. So the company didn't go away. What happened to the shares?)

I found a table of stock market returns during various time periods. The World War II period is shown from 1939-1948. U.S. is up 24%, U.K. is up 34%, France down 41%, Germany down 88%, Japan down 96%, and the World down 19%. (If the Japanese shares went worthless, wouldn't the loss have been 100%?)

The World War II recovery period from 1949-1959 showed U.S. up 426%, U.K. up 212%, France up 269%, Germany up 4,094%,
and Japan up 1,565%. The World was up 562%.

So the answer seems to be no, the shares did not become worthless.

The article referenced the table from Credit Suisse Global Investment Returns Sourcebook 2011.

The information was part of a Motley Fool article How Stocks Have Performed Through Calamity, War, and Histeria.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nisiprius » Sun Sep 01, 2013 9:51 pm

The proof that that market believes stocks are riskier than bonds is that the Dow did not reach 36,000 in the year 2005.

Glassman and Hassett's book, Dow 36,000, should not be dismissed as ludicrous seat-of-the-pants optimism (like Irving Fisher's "permanently high plateau.") They were quite specific about the prediction, the time frame, and, more important, the reasons.

In discussing the time frame, they said:
"How soon? The rational time frame is this afternoon. But the process will take longer as understanding spreads about the true risk of stocks. A sensible target date for Dow 36,000 is early 2005, but it could be reached much earlier than that."
The reason was that because, in their words, it is an "undeniable historic fact" that "the stock market is no more risky than the market for Treasury bonds."
• The truth is that, over the long-term, stocks are no more risky than bonds or Treasury bills, so…
• With this in mind, investors in recent years have begun to act more rationally, bidding up the prices of stocks and driving down the premium they had demanded when they believed stocks were risky, and…
• Soon, prices will rise to where they will be “perfectly reasonable”—around 36,000 on the Dow Jones industrial average....
In short, again, their words, "The Dow 36,000 theory depends on the risk premium for stocks disappearing."

The fact that the risk premium for stocks did not disappear and that the Dow did not reach 36,000 at or before the year 2005 shows that their premise, that "the stock market is no more risky than the market for Treasury bonds" is incorrect; or, at least, that the market does not believe it.

In 2011, Glassman said that the reason he was wrong was that "the world changed." However, in a sense, that's the point. The risk of stocks includes the risk that the world might change in a way that's unfavorable to stocks.

If you believe that stocks are no riskier than bonds, then you need to explain why the Dow is not currently at about 36,000 in "early 2005 or much sooner," perhaps + 10%/year for 8 years--that is to say, why it is not somewhere around 70,000 or 80,000.

Perhaps the publication of the new edition of Siegel's book later this year will be the catalyst that finally makes investors understand why stocks are no riskier than bonds, causes the risk premium to disappear, and propels the Dow to 70,000 or 80,000. But I don't think so.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby nedsaid » Sun Sep 01, 2013 10:00 pm

This is why I own both stocks and bonds. This is also why I like dividend stocks. The income generated from the portfolio is an important part of its return. I don't want to be completely dependent on capital gains.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby kwan2 » Mon Sep 02, 2013 4:08 am

someone needs to credit Abbie Hoffman in this thread
The best lack all conviction, while the worst | Are full of passionate intensity-Yeats 1919;Out of every fruition of success,no matter what, comes forth something to make a new effort necessary -Whitman
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Browser » Mon Sep 02, 2013 5:57 am

FYI - 30 Year Treasurys were not issued until 1977. They replaced the 25-year, which became part of the U.S. Treasury's mid-quarterly refunding in 1974. http://www.treasurydirect.gov/indiv/research/history/histtime/histtime_bonds.htm The real yield was negative in 1979 and 1980 when inflation was 9.3% and 13.9% respectively. Based on annual yields at the beginning of each year, the average annual nominal yield from 1977-2013 has been 7.1% with an SD of 2.8%. The real yield has averaged 3.2% with an SD of 2.3%. The SD for annual inflation is almost twice as large as the SD for nominal yields; consequently, real yields are more highly correlated to changes in the inflation rate than changes in the nominal yield.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby KlangFool » Mon Sep 02, 2013 9:23 am

Bill,

1) Borrowed the first 2 books via Amazon Prime. Will take a while to get to the third books.

2) Could I asked you some questions on this thread and should I start another thread??

A) As per life cycle investing book, it seems to me that if person is a life time 30+% gross income saver, almost any basic safe (60/40) investment approach will work.

B) Pay off mortgage versus keeping those cash as 5 years reserve. With low fixed interest rate mortgage, it would seem to me that a case can be made to

i) Do not payoff the mortgage and use those cash as part of 5 years reserve

ii) The mortgage as an inflation or interest hedge

Obviously, I have not think through everything.

Those are very good books. I probably buy them all later so that I keep them in my collections..

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby LadyGeek » Mon Sep 02, 2013 9:30 am

KlangFool wrote:2) Could I asked you some questions on this thread and should I start another thread??

Start another thread, then post the link in this thread. You will get better advice and it will help to keep this thread focused on risk.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby cjking » Mon Sep 02, 2013 12:22 pm

bobcat2 wrote:This possible forecast error makes holding stocks riskier the longer we hold them, as the forecast error of the mean compounds.


Only if we define risk as getting a result a long way from the initial forecast. Surely a better definition is getting a lower return than an alternative asset. There's no way I'd entrust my pension to 30-year nominal bonds, that's far riskier than investing in equities, so let's look at TIPS yields. The first page that came up in Google showed the following yields (I don't usually follow TIPS yields so I'm just assuming these are plausible/accurate unless someone says otherwise.)

5-year -0.16%
7-year 0.31%
10-year 0.68%
20-year 1.21%
30-year 1.46%

(My estimate of expected real return for US equities is currently 3.7% annualised.)

With 100% equity allocations over the various holding periods, I would think those with the longer holding periods are more likely to outperform TIPS. So by that definition equities are less risky the longer we hold them.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby bobcat2 » Mon Sep 02, 2013 2:49 pm

With 100% equity allocations over the various holding periods, I would think those with the longer holding periods are more likely to outperform TIPS.

I don't know of anyone who would disagree with that. The problem with 100% equities is when they do under perform it is possible to be by a lot. It's that magnitude of possible under performance where the risk shows up. :(

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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby sperry8 » Mon Sep 02, 2013 2:52 pm

wbern wrote:"Deep Risk," which was covered by Jason Zweig several weeks ago, is finally available in both Kindle and paperback from Amazon.

But bogleheads really have no need to buy it, since Jason's article

http://blogs.wsj.com/moneybeat/2013/07/26/shallow-risk-and-deep-risk-are-no-walk-in-the-woods/

covered it pretty well, and what wasn't got discussed in this thread:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=120512&p=1761508

Jason surprised me by writing his article several weeks before I had it in final form. But if you choose to disregard my advice and spend good money on it, well, I won't try to stop you.

It's available only on Amazon: I won't be making a Nook or iTunes version.

Best,

Bill


Just bought the Kindle version. I'm a Prime member, but don't like to borrow. I don't like to be rushed when I read - and I like to own your wisdom for the ages.

Thanks!
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Allan Roth » Sun Sep 08, 2013 7:03 pm

I really liked Jason Zweig's summary and I wrote my own.

http://www.cbsnews.com/8301-505123_162- ... portfolio/

While I rarely disagree with William Bernstein, I have to recommend you buy his eBook. It's brilliant and far more valuable reading the whole thing than any summary.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby Rodc » Mon Sep 09, 2013 3:53 pm

Inflation is the biggest risk to investors. Even at 2%, it relentlessly chews away at your purchasing power. To beat inflation, you have to take market risk.


While not perfect (what is?), this seems to ignore TIPS for US investors.
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Re: One More "Don't Buy This Book" from Bill Bernstein

Postby BlueEars » Mon Sep 09, 2013 5:13 pm

wbern wrote:...
I specifically excluded TIPS from my "stock/bond" dichotomy, and recommend them strongly for inflation protection. For example, a number of European nations, including Weimar Germany, issued gold-backed bonds, and they did well.

Bill

Bill, do you recommend TIPS now at the current yield (10yr TIPS = 0.8%)? Or would you only buy them at higher (more average historical real) rates?
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