Reading recommendations for the informed investor

David Peartree, BridgeTower Media Newswires

Every year teaches the same lesson but this year, in particular, is a good reminder that the world is a risky place. Some risks we can anticipate and manage, others we cannot. As investors, we can better manage risk the more we are informed investors and, to that end, here are some reading suggestions.

"A History of the United States in Five Crashes" by Scott Nations. Market crashes occur when some catalyst shifts investors into a collective state of fear or uncertainty, triggering a decision to sell known as a rush for the exits. Market crashes expose imbalances in the financial markets that were previously hidden or obvious but ignored.

Market crashes are inevitable but not predictable. The crashes the author explores share some basic elements: "a robust stock market rally that pushes stock prices beyond reason, a financial vehicle that will foster selling at the worst possible time, (and) a catalyst that will start the selling." However, the author does not pretend that there is a sure way to apply the lessons from past crashes to the present. The exact nature of the underlying imbalances and the immediate catalyst for selling change from one crash to the next - making it difficult to apply lessons from the past to the present. Timing is another challenge.

That doesn't mean that the author's review of financial history is without practical value. The author describes the role of what he calls "financial contraptions" plays in each crash. Financial contraptions are either financial products or busines models that are more complicated or risky than thought and often employ leverage, or borrowing, in the pursuit of greater profits. The 2008 crash, for example, involved massive amounts of securitized mortgage debt of questionable value. Understanding the troublesome characteristics of certain "financial contraptions" can help investors to avoid trouble.

Also, he affirms some "old-fashioned" advice, particularly the value of diversification. Diversification is important because while we can learn valuable lessons from the past, we still can't predict the future. If we knew what the future would bring, we wouldn't need to diversify, but we don't know, so we diversify.

"Rational Expectations: Asset Allocation for Investing Adults" by William Bernstein. Readers who are ready to dip their toes into portfolio theory might start by understanding the role of asset allocation. William Bernstein is an interesting guide because he was, until he retired, a practicing neurologist. After becoming dissatisfied with the financial advice he was receiving, he decided to figure things out on his own and went on to become a leading financial thinker and the author of six books on portfolio theory, all directed to the lay person.

Asset allocation can be thought of as the "90% solution." Studies have shown that 90% or more of investment returns - both the variability and the absolute level of returns - is determined by how investments are allocated across different asset classes and not by security selection or market timing.

Bernstein explains that asset allocation is one of the few things investors can actually control that has a significant impact on performance. He takes the reader through a discussion of why this is so and how to build portfolios by sensibly choosing and allocating among asset classes.

"The Intelligent Investor" by Benjamin Graham. This book deserves to be on the top of any one's reading list as an investor. Warren Buffet's testimonial alone is a sufficient endorsement: "by far the best book about investing ever written." This classic was written by the man who Buffet credits as his mentor. Buffet studied under Graham at Columbia Business School and later worked for Graham at his investment firm, the Graham Newman Corporation.

Benjamin Graham is known as the father of value investing. This book provides the intellectual tools to distinguish "investment from speculation" and to differentiate "the market price from underlying value." Says Buffet, "(t)o invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or insider information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline."

The Intelligent Investor was first published in 1949 but it remains relevant today as it is updated periodically with commentary by a financial writer from The Wall Street Journal.

"The Little Book of Common Sense Investing" by John C. Bogle. Bogle was a prolific writer, and virtually anything he wrote about investing is worth reading. This book is his most compelling argument for index fund investing. As the founder and CEO of The Vanguard Group, Bogle launched the first index fund, an S&P 500 index fund, in 1976. Index investing initially met with much skepticism and Bogle was mocked by some competitors for striving to be "average." Bogle, however, was willing to play a long game, and he lived to see his ideas revolutionize investing for millions of investors.

What's particularly interesting is how the views of Benjamin Graham and Warren Buffet came to intersect with Bogle's argument for index investing. Graham is considered to be the intellectual founding father of security analysis, the discipline of evaluating and selecting individual securities with the aim of achieving superior investment returns. Buffet is his most famous and perhaps most successful protégé.

Both Graham and Buffet are idolized by stock pickers, yet late in their careers both became fans of indexing as a more sensible and successful approach for most investors, whether individual or institutional. Graham's thinking on this topic is discussed in his book, "The Intelligent Investor." Buffet's views can be found in several of his annual reports to shareholders of Berkshire Hathaway.

Not everyone subscribes to Bogle's views on low cost, index based investing. That's not a bad thing because investors who believe that they can achieve superior results through their stock picking skills serve a valuable role in setting market prices. For those investors, Bogle's book will help them understand the improbabilities they must overcome simply to do as well as the market after taxes and expenses. For those who want to explore the case for index investing, this book is a solid start.

Read, enjoy and profit.


David Peartree JD, CFP is a registered investment advisor offering fee-only investment and financial planning advice. This column is a collaborative work by David Peartree and Patricia Foster, Esq. Patricia Foster is a securities law attorney whose experience includes representation of clients in various sectors of the financial services industry, including, broker-dealers, investment advisers, and investment companies. This article is provided for educational purposes and does not constitute investment advice. You should consult with your own tax or investment advisor.

Published: Mon, Jan 25, 2021