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Book Review: The Intelligent Asset Allocator
How to Build Your Portfolio to Maximize Returns and Minimize Risk
by William Bernstein, PhD, MD
BFN Book Reviews
Every Thursday I have been reviewing a personal finance book. I provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.
What is this book about?
As you probably have already figured out, this book is about investing and, specifically, asset allocation. The author discusses numerous investment concepts covering both theory and practical advice. Be warned, however, the information you read here will not be what you would hear from a typical financial advisor (well, maybe a fee-only one). The author presents this book as a guide to enable a normal person to construct and manage his/her own investment portfolio.
Who is the author?
William Bernstein is not a financial advisor or a wall street analyst. Instead, he is a neurologist. So, I’m not sure if that makes him less qualified or more qualified to write this book. He writes the book not as an expert in the field but as a person, probably like you and me, who desires to figure this investing stuff out for himself. Dismissing the typical wall-street wisdom and advice from self-serving brokers, his philosophy is that a normal person can do a good job of managing his/her own portfolio. Bernstein also maintains efficientfrontier.com which provides investing and asset allocation resources.
What are the best parts of the book?
There is a great deal of theory in this book but it is also packed with really practical, useful information. Bernstein gives practical information and backs it up with statistical analysis. Here are some of the really valuable concepts that the author provided in this book (don’t worry – I won’t bother you with the statistics – you can read the book for that information)
- Effective portfolio diversification can increase return while reducing risk (diversification means creating a portfolio of multiple non-correlated or weakly correlated assets)
- Adding a small amount of stock to a bond portfolio increases return and reduces risk
- Adding a small amount of bonds to a stock portfolio significantly reduces risk while reducing return only slightly
- Favor short-term bonds (6 months to 5 years) rather than long term bonds
- Indexing is the best way to invest
- One possible exception: Small-cap growth stocks
- Periodically re-balance your portfolio back to your target allocation
- Sticking to your target asset allocation through thick and thin is much more important than picking the right asset allocation
- Value investing typically returns more than growth investing (good companies make
- The market is not exactly a "random walk" – a good return this months means a slightly better than average chance of a good return next month.
- Dynamic asset allocation – changes in allocation that are purely market valuation driven are likely to increase return. Changes in response to economic or political conditions are a very bad idea.
- There are more expenses to an actively managed mutual fund than just the management expense fee disclosed in the prospectus:
- Expense ratio
- Commission ratio
- Bid-Ask spread
- Market-impact costs
The author also provides these key pieces of knowledge and advice as a final summary:
- Risk and reward are inextricably intertwined
- Those who do not learn from history are condemned to repeat it
- Portfolios behave differently than their constituent parts
- For a given degree of risk, there is a portfolio that will deliver the most return; this portfolio occupies the "efficient frontier" of portfolio compositions
- Focus on the behavior of your portfolio, not on its constituent parts
- Recognize the benefits of rebalancing (but not too often)
- The markets are smarter than you are; they are also smarter than the experts
- Know how expensive the tomatoes are (investigate Price/Earnings, Price/Book Value, Dividend yield)
- Good companies are usually bad stocks; bad companies are usually good stocks (Lowest P/E stocks typically outperform highest P/E stocks)
- In the long run, it is very hard to beat a low-expense index mutual fund.
In the interest of brevity, I won’t go into the detailed explanations of these concepts or his advice right now (Don’t worry, though, I plan on doing numerous posts on these investing concepts in the future). If you’re intrigued by some of these concepts and more more information or you don’t believe the author and want the proof behind them, then you should grab a copy of the book and delve into it.
The three questions to ask yourself when determining asset allocation
The author shows you how to use your answers to these questions to determine a comfortable asset allocation:
- How many different asset classes do I want to own?
- How conventional of a portfolio do I want (how much difference from the S&P 500 can I tolerate?)
- How much risk do I want to take?
Besides the theory and concepts, there is also some very practical information
The author also describes various example asset allocations tailored to how many different types of asset classes you want to include in your portfolio. He also includes a table that lists actual mutual funds to use in your portfolios. He even divides this table into three sections describing which funds are best for tax-sheltered accounts, taxable accounts, and those that are acceptable for either type.
What is not-so-good about the book?
I did not find much bad information in this book. Actually, the biggest issue with the book is that there are a lot of statistics in it. That can be good or bad, depending on your perspective. If you don’t really enjoy reading a lot about the details of the numbers, then this book will be a tedious read for you. In fact, on Bernstein’s website, he notes that this book is "for the Sophisticated Investor" while his similar book, The Four Pillars of Investing 
So what is my recommendation?
If you are not concerned with the mathematical details of why asset allocation and low-cost investing is important, then you probably don’t really need to read this book. Instead, you might want to read Paul Farrell’s The Lazy Person’s Guide to Investing. That book ascribes to the same investment philosophy. It will provide you with some practical examples of actual investment portfolios without bogging you down with all the theory and math.
If you are really interested in understanding why asset allocation is so important, then I think this is a good book to read. As I mentioned, this book contains some really useful and informative information covering both theory and practical advice. I have repeatedly mentioned that the book contains a lot of statistics, but don’t let that scare you. It’s not like this is a statistics textbook (and you can always skip a section or two if you want).
I would say that this is a good candidate for checking out from your local library. Borrow it, read it (maybe renew it), digest it, and become much more knowledgeable about what is important when constructing your portfolio and get inspired that you can do it yourself and do it well!
Want to borrow this book? Search your local library
Want your own copy? Buy this book now at Amazon.com
Check out the books I’ve chosen for my virtual bookshelf
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