Benjamin Graham was Warren Buffet’s mentor. Warren Buffet has plainly stated many times that he has always used Graham’s investing principles as his main guide. Buffet recommends Benjamin Graham’s Intelligent Investor as the main way to understand Graham’s philosophy and investing in general.
Its a great book. Graham writes concisely and clearly. If you’re thinking about investing at all – and probably even if you aren’t – you should read this book first.
Unfortunately, the first time I read it I didn’t really heed one of his biggest pieces of advice. One of the principles is to be either a defensive investor or an “enterprising” investor. I tried to be some of both.
The defensive investor seeks to get the market average with minimal effort and costs At the time he last updated his book, index funds hadn’t been made yet, so its really easy to be a defensive investor. The problem with being a defensive investor is that its too boring for a lot of people. Index funds make defensive investing even more boring because no one goes to the party and brags about how they performed exactly like market.
The enterprising investor tries to get extra return on his money by putting in a significant amount of effort studying companies and the market in general to find the best deals out there. Graham states that it is exceedingly difficult to beat the market and that many professionals with years of education fail to beat the market or, more commonly, lag the market. However, being an enterprising investor is more fun and interesting. Also, if you can brag about your big wins – even if you have a bunch of failures.
You can’t be half defensive and half enterprising by putting in a little extra time above being defensive because then your enterprising actions will fail and often do worse than just staying defensive. I tried to be part enterprising and I think I did a little worse than the market. Since I’ve just had a baby and have basically no spare time to put into investing research, I’ve switched all my money over into index funds. My life is much better because of it.
One caution flag that Graham throws up is to make sure you don’t become a “speculator” when you think you’re investing. If you’re making guesses or hoping or wishing that a company will do great then you’re speculating. He believes that many people are speculating and calling it investing. I think he’s right. All those people who are saying what the market will do in the short-term and all those people who are actually pulling themselves in and out of the market on a regular basis are speculating. Day traders are speculators. Speculators tend to lose. A lot. A lot a lot. They don’t all lose and they often have big wins, but those wins usually are outweighed by their losses. There’s nothing inherently wrong with speculation. It can be fun and entertaining. You can guess right and make a lot of money. The problem is when people speculate and think they’re actually investing.
Now that I’m a defensive investor (at least for now), I’ve just made a simple portfolio that will automatically buy low and sell high. Graham recommends having at least 25% bonds (and subsequently 75% stocks). So I’ve got 25% bonds, but it won’t stay that way all the time. If stocks go up and, typically, bonds go down as people sell bonds to buy more stocks, then bonds may move to be 20% of my portfolio. In that case I would “rebalance” my portfolio back to 25% bonds. I’ve just sold stocks high and bought bonds low. The reverse situation works the same with bonds having risen when stocks go down. Stocks and bonds don’t always go in the reverse direction, so its not that simple, but by and large that’s how they act.
If its so easy to buy low and sell high, why doesn’t everybody do it? Well, people tend to get caught up in the enthusiasm of the market when its gone up a lot lately. They also tend to get caught up in the despair of the market when its gone down a lot lately. Our instincts and traditional wisdom fails us when it comes to managing our investments.
Typically when something/someone has done really well lately, the trend will continue. For example, when a professional athlete has been on the rise lately, its a good bet to guess that they’ll continue to rise or at least not fall back to previous performance levels. Another example is the relationships we have with people. When someone comes through for you over and over, its safe to bet that they’ll come through for you in the future.
Unfortunately, the stock market doesn’t work like that because at it goes up and most people want to buy more, they’re not realizing that they’re basically paying more for the same things. When the market goes down people should be thinking, “its on sale! Wahoo!” If the cereal you buy doubles in price temporarily, does that make you want to buy more? What if it halved in price temporarily? The same basic concept applies to the stock market because there is a company behind that stock and going up or down significantly in a short period of time doesn’t really change the value of the company (with few exceptions – see banks).
There are so many more easily understood concepts in Graham’s books that reading it really changes your perspective on investing. However, the basics I just talked about I wish someone had emphasized to me a long time ago.
