Saturday, April 18, 2009

Richard Bernstein's Investment Guidelines

A blurb in the Wall Street Journal's "Heard on the Street" section caught my eye as I was on my way in to work last week:

"Overheard - Most people gush thanks (or occasionally spit bile) in their farewell address. Richard Bernstein, whose 20 years at Merrill Lynch drew to a close on Wednesday, went 10 steps further. In a final note, having thanked colleagues and clients, the bank's chief investment strategist signed off with 10 guidelines. All are worth remembering, but perhaps the last resonates strongest: 'Leverage gives the illusion of wealth. Saving is wealth.'"

This caught my eye and I made a mental note to see if I could find the complete list of 10. Lo and behold, through the magic of the Internet, I found the guidelines on seeking alpha.
They are the following: 
1. Income is as important as capital gains. Because most investors ignore income opportunities, income may be more important than capital gains.

2. Most stock market indicators have never actually been tested. Most don’t work.

3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.

4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.

5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.

6. Balance sheets are generally more important than income or cash-flow statements.

7. Investors should focus strongly on GAAP accounting and should pay little attention to “pro forma” or “unaudited” financial statements.

8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.

9. Investors should research financial history as much as possible.

10. Leverage gives the illusion of wealth. Saving is wealth.

I thought these were some pretty good observations. Number 1 definitely hit close to home for me. As I've grown my savings more over time and seen the impact a huge market downturn can have on the value of certain stocks, I've begun to pay a little more attention to income. Although I still believe capital gains are where the big payoff comes from in stocks, income is something tangible and shouldn't be overlooked. Number 5 is pretty important as well... over the past 2 years, people have seen every single asset class in their "diversified" portfolios sink almost in unison. Many were operating under an illusion of diversification and when the tide went out, we saw who wasn't wearing a bathing suit. 

I cocked my head sideways when I read number 4 because I think nothing fuels a bull market more than cheering and a rush to buy. I kind of see his point though. He is saying bull markets are more the result of assets being unfairly punished and undervalued prior to the bull market than the actual enthusiasm during the bull market. In my opinion, you can't have one without the other so this is kind of a circular argument.

This list reminded me of another post I made a while back on nine market lessons from John Dorfman, a Bloomberg columnist who retired a while back. For the sake of completeness and comparison, I list Dorfman's lessons here:

1) Out-of-favor stocks are the best road to capital gains.

2) Don't be swayed by what Wall Street analysts say.

3) High portfolio turnover is not necessary for good results.

4) The investment value of a stock is independent of whether it has been moving up or down.

5) Predicting the market with consistency is extremely difficult.

6) Predicting the economy is probably even harder.

7) High valuations alone aren't a good reason to sell a stock short.

8) High profits alone are no reason to invest in a stock.

9) Dialog with readers was one of the best parts of my experience as a columnist

Maybe one day I'll come up with my own list, but I have no plans to retire anytime soon :)

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