William Bernstein is an unlikely financial theorist. He holds a doctorate in organic chemistry and was a practicing neurologist before abandoning an honorable medical career for a far more dubious pursuit: lending professional financial advice. He now runs a boutique investment service called Efficient Frontier Advisors LLC that serves clients with portfolios worth at least $25 million. He also has published a suite of books, including practical guides that teach readers with varying degrees of financial expertise to apply his favorite principles to their own lives.
Bernstein, who lives in Portland, Oregon, says he is now more focused on “eleemosynary” (or charitable) acts. That’s why last year he published a free online booklet of investment advice for millennials -- perhaps the most distilled and accessible version of his financial theories to date. In “If You Can,” Bernstein lays out a disciplined and sensible approach to saving for retirement.
International Business Times asked him about the most common financial pitfalls that plague young investors, how to weigh decisions like paying off student loans versus saving for retirement, and why anyone should trust the advice of a neuroscientist-turned-financier.
International Business Times: How did you learn to manage your own money when you were starting out?
William Bernstein: I was pretty much figuring it out by myself. I'm trained as a scientist and I figured, well, investing is a science and I’m going to go into the peer-reviewed literature and figure it all out. That was helpful. I realized it's all about asset modeling and I was going to have to build some models. I collected data. I had to teach myself how to use a spreadsheet. So I built these models and I realized that I had done something that might be of value to ordinary investors. About that time, the Internet came along, and so I wrote a book.
IBT: Why did you write a financial how-to for millennials, who have so little money to work with?
Bernstein: They’re the only ones that there’s any hope for. If you look at the Center of Retirement Research data, they have this little index called the Retirement Risk Index. It’s at 52 percent, so 52 percent of people have their retirement at risk. The bottom line is the boomers are toast. But the millennials, they’re going to sink or swim.
IBT: What do you think is the single most effective action that millennials can take to point them toward a wealthy future?
Bernstein: Save like hell. Having a roommate until you're 35 may not sound very appetizing ... but that's not half as bad as living under a bridge when you’re 70.
IBT: You’ve said that millennials shouldn’t ever dip into their savings to make big purchases such as a car or laptop. How do you suggest they pay for these items?
Bernstein: It's simple -- always pay cash. Do not take out a loan to buy a car. And if you have to drive a clunker for more years than you'd like, there are very much worse things in life, and you may incur them if you run into too much debt trying to buy a Beemer when you're 28. Drive that 15-year-old Honda Accord.
IBT: You’re a big proponent of living below your means. Why is that so hard to do, and where do you see people going wrong?
Bernstein: We live in this relentlessly consumer-driven society. If you don’t have the latest iPhone, if you're not driving a Beemer, if you're not living in a mansion and going to Bali and Paris each year, you're somehow a failure. Unfortunately you're dealing with a very deeply ingrained culture in this country and I'm afraid that's going to be the hardest part. Most young people aren't going to be very receptive to that idea.
A lot of people make fun of the “latte theory” -- if you only don’t drink a latte every day, you'll save enough money to retire on -- and that's of course not true. But the latte is one thing that can save you $600 or $1,000 a year, and if you string together six or seven of those, and you can invest well, you can retire.
IBT: A point of clarification: In “If You Can,” you recommend that millennials begin saving 15 percent of their income for retirement from the moment they begin working. Is that 15 percent coming from pre-tax or post-tax income?
Bernstein: That’s before taxes. You're going to wind up putting it into a tax-deferred vehicle and you'll deal with the taxes later when you're older. If you do have a tax problem when you’re older because you’ve saved too much, that's a good problem.
IBT: How should early career professionals think about paying off their student loans? Is it better to pay off as much as possible up front or to pay them off gradually so that you can divert more money to retirement?
Bernstein: It’s a math question. Basically what it boils down to is: Which is higher, your loan interest or the return you're going to get on your investments? The nominal return on a mixed portfolio, if you’re lucky, is 5 or 6 percent because things are so overpriced and overvalued right now. So if you've got a student loan and the rate is much lower than that, pay the minimum on the student loan. But if you're paying a student loan and the interest rate is higher than that, yeah, get rid of that. And of course, the first thing you get rid of is credit card debt.
IBT: What should millennials consider when weighing the decision to take on more debt, such as a mortgage, while still paying off loans?
Bernstein: Again, it's a math question. Really the question you're asking is, Do I rent or do I own? There’s a rough-and-ready number you should always keep in your head: 168. What's magic about 168? That’s the number of months in 14 years and that's the equivalency point between renting and owning. So look at the house and let's say you could rent for $2,000 a month. That means you shouldn’t pay much more than 168 times that: $336,000. So if you can get that place that you could rent for $2,000 a month for less than $336,000, you should buy it. If you can't, you should continue to think about renting. There's a lot of reasons to own a house but not as an investment.
IBT: You advocate for a style of investing known as equity or index allocation, which means buying a swath of investments in the form of mutual funds, bonds and stocks rather than making individual purchases in each of those categories. Why do you think this is the best way to invest?
Bernstein: It's very simple. When you buy a stock or a bond, there's always somebody on the other side of that trade. And that someone generally has a name like Goldman Sachs or Warren Buffett. It’s kind of like you're playing a game of tennis with an invisible partner and what you don’t realize is the person on the other side of the net is Serena Williams. That’s not a game you want to play. Which means you buy the whole market and that's the only way to win. You're buying everything and you eliminate the Serena Williams problem.
There's now 80 years of empirical data that shows that no matter how smart you are, there’s almost no skill in money management. So when you're playing that game, what really determines the returns you get is how much expenses you're paying along the way. So why you would ever pay a market fund manager 1 percent a year when you could own the whole market, which will beat 70 to 80 percent of market fund managers? It's beyond me why you would ever want to do anything else.
IBT: You have repeatedly warned about dealing too much in stocks. You’ve written: “How risky are stocks? You’ve no idea.” But others argue that young investors are also poised to make the most from stocks precisely because they can afford to take more risk and have time to recover their losses. How should young professionals incorporate stock into their portfolio while minimizing the risk that they’ll get burned?
Bernstein: The fundamental rule of the capital markets is that you are compensated for taking risk. So one way of putting that is you can’t get high returns without taking risks, which means getting hammered now and again. If you want perfect safety, you're going to have to live with lower returns. There’s simply no way around that.
The problem most people have is they think there’s a market timing or stock picking theory that's going to let them make a run around it. Charlie Ellis [investment consultant and founder of consulting firm Greenwich Associates] very famously said you can win the investment game in one of three ways: You can be smarter, you can work harder or you can be more disciplined than anyone else. The problem is, the first two things are impossible because Wall Street attracts the best and the brightest. You’re not going to be the hardest working because there are people working 100 hours a week in financial trades on the other side of you.
The way you can stay in the game is by being psychologically disciplined. It’s being able to look at the news and say, “Oh my God, China is imploding,” and you have to be able to tune that news out and ignore it. That’s the discipline game. And you really have no idea, no idea at all, until you actually start investing with real money, how good you are at that head game.
IBT: Even though you’re technically a member of the financial services industry, you warn young investors about paying anyone to manage their money. Why are you so skeptical?
Bernstein: There is no “returns fairy.” There’s no one out there who runs a mutual fund or hedge fund who's going to make outsized returns for you. They may seem to exist -- you may see people who appear to have done very well. They're lucky monkeys, but the people who have done the best returns over the last 10 years are not likely to be the ones to make the best returns in the next 10 years.
IBT: In “If You Can,” you suggest a few books that provide solid financial advice, including “Common Sense on Mutual Funds” by Jack Bogle, the founder of the investment management company Vanguard Group. Where else can people go to find this sort of guidance?
Bernstein: That’s easy. Go to bogleheads.org. It's the Vanguard die-hards. Jack Bogle is the patron saint of this group of people. These are wonderful, wonderful people and it's a big forum and there’s a wiki on the site that has information about almost every conceivable financial and investing product you could want. All you have to do is log on, get an account, and say “Help!” And you'll be plugged in.
Of course, the formal Vanguard site itself is a wonderful resource. People always say I'm a shill for Vanguard, but here's the thing: It’s owned by fund investors, and since those are the owners, the interest Vanguard serves is keeping fees as low as possible. It’s the only thing they want to do. They're the one exception to the evilness of Wall Street.
As far as the history goes, the place to start is a book by Edward Chancellor called “Devil Takes the Hindmost.” If you read one book about finance history, that should be it. The book, by the way, that I read that probably saved me millions of dollars in the end was a book that was published in 1841 called “Extraordinary Popular Delusions and the Madness of Crowds.” It's downloadable on Google books ... and you can certainly get it from your public library.
IBT: What questions should new employees ask about their 401(k) to decide if it’s worth contributing more than what their employer matches?
Bernstein: Really it hinges on do you have a good 401(k) plan or not? If the answer is yes, you have a good 401(k) plan with inexpensive choices, you should contribute beyond the match. How do you know if you have a good plan? That's easy, just look at the expense ratios of the funds it contains. If you're looking at funds of 60 to 80 points or higher, you have a lousy plan and you should contribute up to the match and fund your own IRA. If your plan is filled with funds from Vanguard, then you know you have a good plan and you should be contributing beyond the match, especially if you've got the Vanguard retirement target fund plans. Really, the easiest and simplest thing to do is put all your money in that and forget about it, because those are really nicely balanced funds. Just fire and forget; put all your money into it and don’t ever look at it again.
IBT: You graduated from medical school and have a degree in organic chemistry. Why should anyone listen to your advice about personal finances?
Bernstein: Oh, it's very simple -- you don’t have to take my advice about anything. Ninety-nine percent of what I do is just writing about other people’s work, so you can go and look at that. You can be agnostic about every single thing I say and go and look at my reference sources.