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Retirement Planning > Retirement Investing > Income Investing

Five Good Questions for William J. Bernstein of 'Efficient Frontier'

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William J. Bernstein is the editor of the quarterly asset-allocation journal Efficient Frontier, founder of the popular website, and a principal in Efficient Frontier Advisors. He is often quoted in national publications, including The Wall Street Journal, Barron's, Money, and Forbes

He is also the author of The Four Pillars of Investing, The Intelligent Asset Allocator,  The Birth of Plentyand A Splendid ExchangeBill graciously agreed to be my guest for the inaugural edition of what will be a regular feature for my AdvisorOne blog, in which I will endeavor to ask and receive answers from interesting people to Five Good Questions.

In your excellent book, The Birth of Plenty, you outline four primary elements as the building blocks of human progress – property rights, scientific rationalism, capital markets, and transportation/communication.  Are any of these at risk in America today and, if so, how?

It’s an interesting question, and one I’ve not been asked before.

It’s quite obvious that as a nation we’ve become fat, dumb, and lazy: a very high percentage of our science graduates, for example, are foreign born, and an additional large slice is first generation Americans.

We overconsume and undersave, particularly on educational, social, and transport/communications infrastructure; it’s a scandal, for example, that the water system of our largest city is more than a century old. Every time I go through a European train station or an Asian airport I’m embarrassed for our country.

The good news is that none of those things, except possibly the last, reflect on the crucial four factors: our institutional infrastructure, which is the world’s best, bar none. It’s not just that we have open and free capital markets, universities, and an independent judiciary that protects individual liberties and property rights, it’s also that we do a superb job of intellectually and financially nurturing our best and brightest.

If you don’t believe that, then ask yourself what would have happened to Bill Gates if he had dropped out of the Sorbonne or Tokyo University. Or ask yourself, if our educational system has been falling apart for the past half century, why we’re still pulling down the lion’s share of science Nobels. 

So I’m still optimistic; even if we’re getting lazier by the generation, we’ll still attract the global cream of the crop here.

You have argued, here for example, that extreme income and wealth inequality hinder economic growth and are bad for our economy.  In brief, how do you suggest we try to correct that problem?

Well, I’m going to show my political stripes here. When people read Birth of Plenty, they assume I’m a libertarian, because of the book’s emphasis on property rights.  But at the end of the day, “property rights” is nothing more and nothing less than the respect that folks with less than you do have for your property, and if there’s too much spread between the rich and poor, that erodes that respect and property rights enforcement costs skyrocket. 

There is no question that economic inequality is killing us; we have the highest rates of obesity, homicide, violent crime, and incarceration in the developed world, things that all covary strongly with inequality.

If there’s one myth that’s more corrosive than any, it’s the notion of “job-killing taxes.”  By that logic, Somalia should be the world’s richest nation, and Sweden and Switzerland the poorest; Massachusetts ought to be our poorest state, and Mississippi the richest.

It’s a brutal fact that in highly productive societies, a lot of income needs to be redistributed. The objective evidence on the subject suggests that marginal tax rates have to be very high — in the range of 70%-80% — before the income effect becomes overwhelmed by the incentive effect; I find it hard to believe that Bill Gates, Larry Page, or Mark Zuckerberg are going to work any less hard if their income tax rate jumps to 45%. 

(Parenthetically, I might also add that before the Reagan era, the period of highest U.S. economic growth, we had top marginal rates in excess of 90%. And yes, when states raise income tax rates, jobs leave for low-tax states. But that’s only because we give the states far too much autonomy on that score. Take away the ability of states and municipalities to tax, and that problem disappears.)

I’d better stop talking before folks start picketing at my doorstep!

What essential services can and does a good financial advisor provide?

The three most important things are, in order, discipline, discipline, and discipline: the ability to maintain a strategy no matter what CNBC and USA Today are blathering about. After that, the humility to know that you cannot predict market movements and the historical awareness to know that economic forecasts are usually contrary indicators.

In economists’ terms, one of the foundational aspects of a person’s utility function is the intertemporal marginal rate of substitution, one’s willingness to forego current consumption in order to consume more in the future.  Do you have any practical ideas for accomplishing that, particularly as it relates to retirement planning?

I’ll forego the 50-cent words and simply say that wealth is not a dollar amount, but rather a ratio measured in years: in other words, how many years’ living expenses you’ve saved.  The person with a million dollars who needs to spend only $50,000 annually is twice as rich as the person who needs $100,000.

If you think that your happiness is tied up in the things you own, then you are both sadly misinformed about human neuropsychology and doomed to be unhappy. Bottom line: keep your expenses down, save like hell, don’t stop until you’re pushing up the daisies, and look for “utility” in the things that really matter: connections with other people, competence in a vocation or avocation, and most importantly, acquiring autonomy over your time and effort, i.e., becoming your own boss.

If you can’t reach those three goals by the time you’re in late middle age, you’re toast.

A related question — if a commitment device is something that “takes choice off the table,” what commitment devices might advisors use to help their clients plan better and save more?

I’m not sure I know how to answer that one. I’m too old to be nagging people to spend less and save more; it’s a lot simpler and easier to not work with folks who don’t know how to live within their means.


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