# The Four Pillars of Investing by William J. Bernstein - Blinkist

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.

The diving firm shares rose dramatically for a time. But the businesses never developed operations, let alone profits. Once obvious to investors, the mania quickly ended. Total losses ensued, much like the dot-com crash centuries later. The diving schemes essentially had no sound business model.

Periodic speculation in dubious ideas is nothing new. Here's a hypothetical: Suppose your neighbor Fritz, a retired engineer, believes there's oil beneath his land. He needs cash for drilling. The odds look poor, but you value the slight chance at millions. After discounting for risk, you might pay a few hundred dollars for a share of potential profits.

The point is, low-probability investments can rationally trade at some price. Values fluctuate with changing risk appetites. The unusual part is when investors abandon reason and get swept up in euphoria, bidding prices ever higher. This speculative mania creates bubbles.

Economist Hyman Minsky identified preconditions for bubbles: a destabilizing new technology or financial innovation, easy credit access, forgetting past bubbles and inexperienced investors dominating markets. Add in irrational euphoria and you’ve got a recipe for financial mayhem. 

Consider the late 1990s dot-com bubble. Online trading was the new technology, and credit loosened. Those burned in 1929 were long gone. And previously prudent investors got caught up in the mania. Fund manager Cliff Asness described the intoxicating appeal as something like video poker engineered to always pay out. Bubbles lure people to financial ruin.

The cycle is clear: displacement, easy money, amnesia, euphoria. Prices detach from reality as greed takes over. Historian Charles Kindleberger wisely observed that “nothing is so disturbing to one’s well-being as to see a friend get rich.” The mania feeds on itself until the fuel of borrowed cash is exhausted, then collapses.

In this way, this boom-bust cycle repeats itself across centuries, currencies and assets. The specifics differ, but the psychological dynamics prove constant. Understanding this is critical for investors today.

Sustainable investing requires patience plus perspective to resist manias in the heat of the moment. Sober evaluation of risk and reward protects us when others abandon reason. Sufficient history knowledge, though never perfect foresight, is the essential ballast for navigating every investor’s perilous journey.

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. 

Also in the 1970s, psychologists Daniel Kahneman and Amos Tversky researched cognitive biases distorting decision-making. In one famous paper, they outlined systematic mental errors people make when estimating probabilities and risks. Though not immediately relevant to investing, their work laid the intellectual foundation for exposing irrational investor behaviors. Let's dig deeper into three of the most costly investing behaviors. 

The first of these is herd behavior, which is deeply rooted in human social nature. We feel comfortable following the crowd and going along with popular trends. But in investing, following the herd is extremely dangerous. Stocks become overvalued as prices get bid up by investors all rushing to buy the same “hot” assets. Eventually valuations detach from reality, returns plummet, and the crowd rushes for the exits. Chasing short-term trends guarantees buying high and selling low. Yet we feel safety in numbers, and following the crowd requires less effort than independent thinking.

Our second big costly behavior is regret avoidance. Humans hate admitting we made mistakes, so we avoid selling losing investments in hopes they’ll rebound. We want to delay facing failure. But whether a stock rose or fell should not control sell decisions. Stocks must be objectively re-evaluated on future potential, detached from past performance. Emotional avoidance of regret leads to pouring more money into doomed positions rather than cutting losses.

Third and final on our most costly behavior list is mental accounting – separating portfolios into winner and loser investments. We become over-focused on small successes, ignoring bigger failures. But only total returns matter. Cherry picking cases of brilliance is delusional if the overall investment strategy fails.

These three innate human tendencies, among others, corrode wealth as surely as rain erodes unprotected hillsides. We treasure our wins and bury our losses instead of facing hard truths. In investing, this enables ignoring overall portfolio failure, eventually guaranteeing misery. The path to success begins by accepting our own irrationality. Then we can intentionally employ strategies to counteract our nature.

With self-awareness, knowledge, data tracking and vigilant rules, we can overcome our own sabotaging behaviors. The keys are objectively monitoring total portfolio returns, learning from mistakes without emotion, establishing systematic discipline and avoiding seductive stories that we invent to explain randomness. While we cannot defeat human nature, by understanding its obstacles we can navigate markets more rationally. The real investing battles take place in our own minds.

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.

Our second strategy is to studiously ignore the past decade's top performing investments when making decisions. Buying yesterday's big winning assets is following the herd mentality of conventional wisdom, which is nearly always wrong in investing. Over multi-year time horizons, we have ‘reversion to the mean’ – meaning today's winners become tomorrow's losers. Market data from less than three decades offers no statistically meaningful signal. Past performance over the short term seldom predicts future returns.

Third on our list of strategies is to cultivate dullness in your investment approach. Exciting assets like hot growth stocks or options have far lower long-term returns versus ostensibly boring indices. If you crave stimulation, take up skydiving or travel to exotic locales – don't seek it in your portfolio. In investing, boring is beautiful. Volatility is the enemy of compounding, so taming volatility through diversification and asset allocation maximizes wealth accumulation. Exciting investments attract the most public attention and money flows, becoming over-owned and overpriced, thus depressing their future returns. Superior strategies deliver slightly less excitement, but far more money.

Four, repeatedly tell yourself: "I will never pick the next Microsoft." Humans exhibit a strong bias to fixate on successes and ignore failures. But for every prominent new corporate giant, thousands of startups fail entirely. Survivorship bias distorts our perception of risk. Admit that you simply cannot predict which rare startups will become huge winners – there are too many variables. Instead, own the entire market so you automatically hold the few big winners that do emerge.

Sound strategy number five is to avoid seductive forecasting narratives. Predicting future scenarios is pure folly. The world is infinitely complex with endless variables, and black swan events ambush us when least expected. Nobody has reliably forecasted macro outcomes, interest rates or market movements for any length of time. 

Six in the list of sound strategies is temper loss aversion, which means objectively tracking total portfolio returns, not individual stock moves. Judge your strategy by overall progress toward financial goals, not the performance of component pieces. Some stocks will fall, but the total portfolio compounds over decades. Don't let isolated drops sink long-term plans.

Our seventh and final sound strategy is perhaps the most important. It’s simply to have patience. No investment strategy succeeds overnight or even over a few years. The math of compounding works, but takes decades to produce dramatic results. Trees grow slowly but inexorably over time. Sustainable portfolio gains require grit – tell yourself that "10 years is a short time in investing". Give proven methods the requisite time to work their mathematical magic.

Overcoming human nature's irrationality is an endless battle, but awareness, incentives and structures can steer us rationally. Admit ignorance, suppress ego and snap judgments, avoid seductive stories and inhibit stimulus-driven actions. With eternal vigilance and a resilient portfolio, we can withstand our own irrationality and steadily build wealth over an investing lifetime.

Final summary

Financial history reveals recurring manias and crashes and the financial dangers they pose. By studying this history, we see the value of compounding wealth through resilient portfolios and long horizons, rather than short-term financial forecasts. Learning from past speculative folly provides perspective to resist frenzied moments and make wiser investment decisions.