Review: The Ages of the Investor

The Ages of the Investor is the first book in William Bernstein's "investing for adults" series. It's unusual in that it provides an unconventional series of recommendations that I don't necessarily agree with, but makes good fodder for thought.

Bernstein looks at lifetime retiring savings as a human capital/financial capital trade-off model. In other words, when you're young, you have plenty of human capital in terms of future earnings growth, but very little in savings. When you're old, the reverse is true. He acknowledges that this view of things is simplistic, in that a young person can nevertheless fall ill, decide to have 12 kids, or do lots of other things to impair their future earnings growth, while his model of financial wealth includes all the risks involved in holding financial securities.

One of the earliest points of the book is that series risk is important. In other words, during your investing career, if you get to take advantage of low stock prices early on, it's a really big advantage, whereas if you get the penalty of a booming stock market in your early years, you don't get to buy stock at low prices, at which point any market crash can really nuke your savings. He points out, however, that if you get a lump sum and invest it all at once, you get to neutralize all series risk, and you avoid extreme outcomes and get to use the market average. This insight doesn't help much, Bernstein admits, because unless you get a big inheritance (or got rich from an IPO), there's no way to find this large lump sum.

Bernstein then examines folks at the beginning of their investing career. This part is not controversial. It's well known that young investors are unnecessarily conservative in their investments (mainly because it takes time to understand financial markets as well as how they react during a downturn), and should actually leverage themselves, as opposed to putting their money in a stock/bond mix. The problem is that most people don't want to use leverage, and even if they did, could quickly panic during a downturn. Bernstein recommends using a DFA-type portfolio instead to increase the risk that they take in their early years.

Then end game is where Bernstein's recommendations are controversial. His thought here is that once you've reached your "magic number", you should avoid taking further market risk. Well, the problem here is that there really is no avoiding market risk except by taking on inflation risk, and for any 30 year period, inflation risk is really high. He suggests a ladder of TIPS (Treasury Inflation Protected Securities), but doesn't point out that TIPS have really poor tax characteristics, and are also paying record low interest rates at this point. He also recommends purchasing an inflation adjusted annuity, but also points out that those have historically been very poor deals. He suggests value stocks, but again, those don't eliminate market risk.

Here's the thing, buying a ladder of government bonds during a period of unusually low interest rates is very likely to send you to the poor-house. Furthermore, once inflation returns, the interest generated from your portfolio would be insufficient to live on. This advice worked well for Robin & Dominguez, but they retired in the 1980s during record high interest rates. I'm not sure Bernstein is doing his readers a favor in 2013 by suggesting a similar route.

The only uncontroversial recommendation he makes here is to delay taking security as late as possible if you're in good health so as to get a great "annuity" from your social security income stream. Of course, if you're a die-hard libertarian I don't expect you to take that advice. Even worse, his examples don't note that those who have their assets in mostly taxable accounts actually have an advantage over those who have most of their assets in tax-sheltered accounts, which is the ability to control taxation through judicious use of when to take capital gains as well as substantial advantages to be found in using tax-loss harvesting. I'm not quite sure what to make of this omission.

All in all, the book makes a bunch of good points and gives you lots to think about, but I find Bernstein's recommendations here thin and not really very strong compared to the resources say, at The Retire Early Home Page. He doesn't even address those issues, or the very important question of how you would arrive at your magic number. While I think the book was worth the very quick read, I cannot give many of its recommendations my endorsement. Read and apply the advice at your own risk.