COLUMN-Bill Bernstein's ways to rewire your brain for investing

Thu Jul 5, 2012 11:18am EDT

By John Wasik

CHICAGO, July 5 (Reuters) - Bill Bernstein is both a neurologist and a money manager, which gives him a unique perspective on the human impulses that he says typically short-circuit people's portfolio decisions. Author of six books, including "The Four Pillars of Investing," he says we need to rewire our brains to do the right things at the right times.

Long a rare voice of wisdom in an increasingly bi-polar market environment, Bernstein says the trick to smart investing is "learning how to behave. You have to fight your worst instincts."

Here are some behavioral guidelines he suggests:

1. Be careful with advisers.

It's perfectly understandable if you don't want to go it alone in investing because there's a lot to know and only a few people are experts. If you choose an adviser, make sure that they are a fiduciary; they must put your interests above that of their firm. They also shouldn't overcharge you, meaning annual fees of less than 1 percent.

And if they aggressively push loaded (sales commissions charged), hedge funds, alternatives or actively managed funds? "Make a 180-degree turn and run," says Bernstein.

2. Buy and hold is okay - then rebalance.

With market volatility soaring in this young century, you have to evaluate how much risk you can take. You need an investment policy statement, which is a roadmap to what kind of stocks/bonds/alternatives allocation is best for your time of life, vocation and personal goals.

Yet you also need flexibility. Maybe a 60 percent stocks, 40 percent bonds allocation is too risky for you. If your plan is working, keep it and rebalance every year to stick to your allocation goals. At the very least, be flexible if your plan isn't working.

"Anyone who says buy and hold is dead should have a neon sign on their head that says `I don't know what I'm talking about," Bernstein says. "It's not buy and hold, it's buy, hold and rebalance. Anyone who's done that over the past 20 years has been mightily pleased with the results, since that person did a lot of buying in the early 1990s, early and late 2000s; and selling in the late 1990s and before the recent crisis."

3. Keep educating yourself.

History is important to Bernstein as he advises his clients. His book "The Birth of Plenty," for example, provides an ample history of capitalism and prosperity. He also posts a reading list on his website. One of his favorites is Fred Schwed's "Where are the Customers' Yachts?"

You should also sample basic online portfolios that employ a handful of mutual or exchange-traded funds. One of the most boiled-down portfolios, which Bernstein recommends, is Scott Burns's "couch potato portfolio," which consists of one-half Vanguard Inflation-Protected Securities and one-half Vanguard Total Stock Market Index fund. There are several other iterations at Assetbuilder.com, which are combinations of low-cost index funds from the Vanguard group.

4. Avoid hot new stocks.

As the recent Facebook initial public offering demonstrated, millions of investors got singed on the notion that they could do a "quick flip" of the stock for easy gains. "How many investors do you think have exerted the considerable effort of estimating Facebook's future advertising revenues? Using the word `investor' to describe these folks is akin to calling Tony Soprano a 'Catholic,'" Bernstein wrote earlier this year on his Efficient Frontier Web site. He figured that Facebook would have to grow its per-share earnings of at least a factor of eight to justify a triple-digit price-earnings ratio. It pays to listen to analysts who sound warnings about stocks and have done sober analyses.

"If neighbors are talking about a stock, stay away from it. If everybody owns it, sell," he says. Bernstein has noticed that the worst investors are empathetic - they feed off of other people's emotions. Investing should be more analytical. Look at the numbers: What's the stock's dividend growth rate? What's its cash flow? What are its business prospects?

5. Admit your ignorance.

Perhaps the best emotional insight you can make is to admit that there's a lot you don't know about investing. It's okay to say this to yourself because you can avoid much stomach-knotting financial anxiety. Make the time to learn what's best for you and your family. Turn off the TV and try to ignore the headlines. You can't be an expert at something that baffles even the most seasoned professionals.

"We don't expect people to fly their own airplanes or take out their kids' appendixes, and yet we expect them to manage their retirement portfolios. In my careers I've done all three, and investing is by far the hardest," he says.

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