William Bernstein on Life Cycle Investing

William Bernstein on Life cycle Investing (With my own thoughts)

1)    Your childhood experience directly affects your relationship with money
People whom are spenders and don’t save, tend to have authoritarian fathers and come from very poor backgrounds. People whom train in architecture tend to value aesthetic changes and spend heavily on it. Nurture and Nature plays a part in the savings and investment behavior of individuals.

2)    Investing for Youngsters
Young investors should be praying for long extended bear markets. An extended sale greatly favors those at the accumulation phase. Defensive investors / most young people should rely on more of their human capital to build up their investment capital base. Enterprising investors may take different paths to suit his performance goals. Stocks are least risky for youngsters as the stocks have more time to recover and grow. 

3)    Investing for Geezers
For Older investors, sequence risk is very important as they are closing retirement. They need to allocate some of their stocks into cash / non-volatile instruments as the next elongated correction could old-live their natural lifespan / retirement drawdown needs. They must overcome natural bias and sell stocks in a bull market to rotate to safe assets, instead of being rudely slapped awake by Mr Market. Stocks are MOST risky for geezers as stocks have less time to recover before being converted to less volatile instruments.

4)    Thoughts about the lost decade
Shallow risk (corrections) vs Deep risk (Lost decade)

Japan lost decade and the US Nifty Fifty is a sombre reminder that stocks can go sideways or not achieve a satisfactory rate of return for decades especially if they are bought at astronomical prices. Always strive to achieve a margin of safety or manage your portfolio allocation even if you are betting on the best companies in the world, and feel free to walk away if the valuations are excessive.

5)    Investing in market downturns
Bad returns usually correlate with bad economic times whereby the risk of retrenchment and losing salary income is severely heightened. Losing your job alongside with huge investment losses directly correlates to losing your discipline in allocating capital to the stock market. Camping and patiently wait for the next market crash stocks sounds easy to follow. In reality, it is exceptionally difficult to stick to allocate capital into stocks in dire economic sentiment and bombarded continually by bad news, least to say <averaging down> on companies that are expected to pose dire financial results in the next earnings release.

6)    Thoughts about leveraged investing
Bernstein’s advice for young investors whom are willing to learn investing, is to explore the basic principles and take it slow. Advanced lifecycle investing principles like leveraged investing through margin sounds intellectually elegant for PHD and Nobel prize award economists. In reality, a sharp market crash and extended downturn could force young investors from shunning the stock market altogether as evidenced in the Great Depression. Leveraged investing is like losing weight, easy to understand but hard to follow especially when faced with a margin call.

7)    Thoughts about true risk appetite
Most people misjudge their true risk appetite and extrapolate the averaged out returns in normalised market conditions, to gauge their risk appetite. In reality, Lumpy stock market returns almost never follow the averaged out returns. The true test of his risk appetite is when a market crashes and the investor is faced with the great unknown. Fear ingrained over the course of thousands of years easily overwrites any rational thinking and it is too easy to simply follow the herd instead of being contrarian. Training for an airplane crash vs manoeuvring your actual vehicle in real time is a very different story.

8)    Does a good memory improves investment returns?
Contrary to Bernstein, I believe merely having a good memory will not improve returns as humans are naturally selective in what they like to remember and blank out traumatic memories. A blog / journalistic approach to record his decisions and unbiased books and records to document his trades is much more beneficial for the investor to objectively analyse his portfolio decisions as well as to spot any trading patterns that may hamper his performance.

9)    Bernstein hierarchy of capital allocation (Best to worst)
My views about capital allocation is contradictory to his views. It is interesting how different key assumptions lead to different conclusions.

i) Lump sum Investing – Allocate a huge lump of capital once it is available and ignore all subsequent market fluctuations. Theoretically, you are compounding a larger sum of money at the onset instead of delaying the compounding effect.

=> Contrary to what Bernstein suggests, I believe most people do not inherit or access sudden windfalls and is forced to make a lump sum investing decision. Bernstein flawed assumptions is that stock markets are always fair valued and not be over-valued in general. Investing lump sums in frothy market valuations like the tech bubble or housing boom in the 2006 period can be exceptionally costly. This approach does not suit my investment style.

ii) Value cost averaging – Set a target growth rate on the portfolio every month, then adjust next month contribution according to the relative gain / shortfall on the original asset base.

=> I do not really understand how this works for a fixed salary worker. If the investor deliberately under allocates his salary for investment purposes, this method may work as he can adjust his allocations higher / lower. For an enterprising investor like me whom allocates most of his salary to Warchest / investments, this method is unsuitable. Notably, I dislike the idea of an theoretical market targeted return as empirical evidence suggests the market in the short term RARELY follows the actual projected returns that was modelled.

iii) Dollar cost averaging – Allocate a fixed dollar sum into stocks on a periodic basis

=> I adopt a variant of this by allocating tranches of capital in accordance to my conviction of the thesis among different stocks / ETFs. Due to my poor ability to market time, I allocate different sized tranches based on my conviction of the investment thesis to hedge against price risk. I will spread out my buys in the event I got the thesis wrong, and there is always the possibility that momentum / falling knifes allow me to catch value buys at lower prices.

10)    Unscientific and false extrapolation by forecasters
From the background of a doctor, stock markets and medical profession share similarities whereby even the doctor or leading authorities are frequently wrong despite presenting an aura of invincibility to outsiders. There is widespread flawed practices by market forecasters to extrapolate past pandemics (Spanish Flu, SARS) into future economic outlook. They conveniently ignore the fact that present industries, accounting practices and technology are different from the past decades.

Investors should not use Mean variance optimisation to optimise their portfolios. There is indiscernible difference between optimal returns VS error maximisers. Despite most formal finance curriculum focusing on quantitative parts about portfolio construction, a key flaw is that each crisis is different, and past correlations may not reflect future changes. Past correlations regress to one in market crashes and may not revert to past correlations as the fundamentals change. Diversification works most of the time until you really need it during market crashes, and leverage / margin calls can blow you up.


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