Name: The Four Pillars of Investing
Rating: 4.5 (17 reviews)
Author: William J. Bernstein

What’s in it for me? Discover the history and psychology behind investing.

Investing today can feel like navigating a financial minefield. Wild market swings, frenzied speculation and complex products dazzle and confuse. It's easy to lose your way in the excitement and get hurt.

Yet building long-term wealth doesn't require predicting every twist and turn. The deepest investing insights come not from formulas or forecasts but from understanding the past. History illuminates the timeless principles and common pitfalls guiding every investor's journey.

By learning from previous generations' successes and failures, we gain perspective to make wiser decisions in the present. This Blink distills this critical knowledge so you can weather any storm and reach your financial goals. Join the voyage of discovery and uncover the enduring pillars supporting successful investing.

Pillar one: Those who don't learn from history are doomed to repeat it

Mastering financial history is absolutely critical for investment success. The same speculative manias, bubbles, panics and crashes have repeated again and again over history, about once a generation. Even if you completely understand theory and psychology, you will still fail as an investor without learning from the past's follies.

Let’s start, then, by turning to economic history and seeing if we can discern some trends.

At its core, technological innovation drives productivity gains, economic growth, and rising prosperity. It is the great engine behind long-term stock market returns. But it's not the absolute level of innovation that matters – it's the rate of progress. If innovation halted suddenly, corporate profits and stocks would fluctuate but cease rising over time.

Importantly, technological progress does not follow a steady, accelerating pace. It comes in intense bursts and blooms. The explosion from 1820 to 1850 was likely the most profound ever. In just 30 years, transportation speeds increased tenfold via railroads. Near-instant communication emerged thanks to the telegraph. The costs of travel and exchanging information plummeted dramatically. Life changed profoundly for people at all levels of society in ways difficult to grasp today. Just a few decades prior, nothing moved faster than a galloping horse. The very nature of time and distance was transformed within a generation.

Consider a useful analogy: technology's diffusion into the economy is like water from an old hand pump. The spurting, irregular flow at the pump handle represents innovation. But the steady stream at the pipe's end is consumption by the average consumer. Capital allocation between these two points is what drives investment returns.

Fascinatingly, investing in pioneering new technologies has yielded low returns historically. Early investors in automobiles and radio companies, for example, got poor results despite backing influential inventions. What matters isn’t so much the merit of the product itself, but the enthusiasm of the public – that’s what drives capital allocation.

Enthusiasm occurs in brief bouts, though. It’s during these short waves of public excitement that era-defining industries get capitalized and towering companies emerge. In the absence of such enthusiasm, investors who provide capital for unproven technologies mostly achieve disappointing returns.

In other words, path-breaking inventions only succeed in those historically rare cases where they happen to catch the attention and enthusiasm of the public.

Pillar two: Sound investing is a game of patience.

Modern stock markets emerged in seventeenth-century Europe. Brokers gathered in coffeehouses in London's Change Alley, buying and selling shares. These primitive exchanges laid the groundwork for sophisticated modern markets.

New financial tools soon enabled public investment in emerging technologies. In 1687, investor William Phipps returned from a voyage salvaging Spanish treasure, captivating the public. Patents proliferated for diving bells to find shipwrecks. Speculators snapped up shares in these diving companies, igniting England's first technology bubble. Only Phipps delivered returns; the rest were fantasies. Investor Daniel Defoe, better remembered today as the author of Robinson Crusoe, went bankrupt on diving company scams.

Pillar three: When it comes to investing, humans aren’t as rational as we’d like to think.

A fundamental assumption of economics is that people behave rationally in their own self-interest when making financial decisions. But abundant evidence proves otherwise – irrationality often prevails, and we frequently act as our own worst enemies as investors. Until recent decades, the field of finance largely ignored the havoc irrational behaviors wreak on investment returns.

In the 1970s, economist Richard Thaler pioneered the discipline of behavioral economics, which studies the many irrational ways people mismanage money. Thaler began by cataloging everyday contradictions, like braving a blizzard to drive to an event just because you’ve already paid for it. Conventional finance theories assume rationality, but real-world observations reveal people consistently act against their own financial interests. A concert ticket worth a couple of hundred dollars is often enough for people to get in their cars and risk death on icy highways.

Pillar four: With training, you can learn to tame irrational impulses.

Triumphing over our hardwired investing shortcomings is immensely challenging yet essential. With consistent effort and self-awareness, we can temper these natural impulses and greatly improve our returns. Let’s take a look at six sound strategies you can start applying today.

First off, avoid overconfidence by clearly recognizing the folly of believing you alone can beat the market's ruthless professionals. Historical data conclusively proves even most savvy investment managers fail to match market returns over time, much less exceed them. What makes you so sure you are the rare exception who finds the elusive holy grail? Be honest with yourself – the market is far smarter and more efficient than any individual investor can ever be. There are countless professionals ceaselessly searching for an advantage. Your odds of success are miniscule in comparison. Admit that the market is smarter than you, and join it as efficiently as possible rather than futilely attempting to beat it. Index funds are the most liberating investment innovation ever created – they allow anyone to match market returns and triumph over the majority of professionals who fail in their efforts to exceed it.

Key ideas in The Four Pillars of Investing

What is The Four Pillars of Investing about?

The Four Pillars of Investing (2002) presents an accessible, evidence-based approach to investing success. The book examines how avoiding emotional biases and impulsive actions enables harnessing the market's wealth-generating power. Bernstein argues that integrating insights from financial science, psychology, and history offers individual investors their best chance at building lifelong prosperity.

About the Author

William J. Bernstein is an American financial theorist who has authored several bestselling books on investing, including The Four Pillars of Investing, The Intelligent Asset Allocator, and The Investor's Manifesto. He helped pioneer the concepts of asset allocation and passive indexing for individual investors, and his academic research focuses on the intersection of financial theory, psychology, and history.