Book Synopsis: The Intelligent Investor by Benjamin Graham

Have read “The Intelligent Investor” by Benjamin Graham many times, and every time I read it fully or even in part – I am amazed by the depth, clarity and advice laid out in the book, and relevant every bit today, irrespective of the fact that it was written in the 1940’s. Such a piece of Investment Advice is available nowhere else in such crisp form for the individual investor. It is almost like financial philosophy, akin to the ‘Bhagavad Gita’ of investing and finance for the individual investor – whenever you pick it, you learn a new piece of investment wisdom every time.

TheIntelligentInvestorIt is difficult to pick up the best parts from such a book which is so all-encompassing – it covers everything from definition of investment to specific criteria for stock selection. Here are some of the key takeaways from the book that are invaluable for the individual investor – many of which are well discussed, but still worth repeating and re-reading.

1. Investment versus Speculation: Graham presents a very clear definition of investing, which in his view, means any operation that on thorough analysis promises safety of principal and an adequate return. Anything not meeting these – i.e. there must be thorough analysis, must promise principal (he does not use ‘guarantees’ but promises), it must have adequate return (which he goes on to elaborate later), and finally, it must be like an ‘operation’ – business-like.

2. Bonds versus Stocks in Asset Allocation: He presents a simplistic 50:50 formula of allocation between fixed income bonds and stocks that works for most investors – giving a leeway of 25% on either side. i.e. at no time should the allocation of either stocks or bonds fall below 25%. The guiding rule is to keep re-adjusting this allocation when one component increases above a certain defined limit, like 60%, by selling the additional 10% of the increased component and buying the other. This does not guarantee the highest returns – but is a mechanical program that is most likely to practically work – simply because it advises selling and buying when it is counter intuitive, and “chiefly because it gives the investor something to do”.

3. Defensive versus Enterprising Investors: Graham makes a distinction between types of investors not based on risk taking abilities or age – as was traditionally thought. Return is not dependent on risk, but rather on the amount of intelligent effort that is put into an investment operation. The Defensive investor will place emphasis on avoidance of serious mistakes and losses, and seeks freedom from effort, annoyance and the need to make frequent decisions. The Enterprising investor will be able and willing to put in time and effort in the selection and tracking of securities that may appear to be better valued than the general market from time to time – which may help him achieve better returns than the market over long periods of time. Majority of investors would fall into the Defensive category. To achieve satisfactory results available to the defensive investor is easier than most people realize, to achieve superior results sought by the enterprising investor is harder than it looks.

4. The famous Mr.Market: This is perhaps the most valuable part of the book – on how to approach the widely fluctuating markets that an investor will face number of times in his investing life. Treat the market as an obliging, emotional partner in your businesses – i.e. the securities of which you own.  Every day, he tells you what he thinks of the value of the share of business that you own, and offers to buy your share at a price or sell you his share at a price. Sometimes his fears overtake him offering you rock bottom prices, while sometimes he is too excited about the future offering you great prices. The best part is he does not mind being neglected – he will come back again tomorrow if you neglect him. Your best interests are then served if you only transact with him if and when you agree with his prices – the rest of the time, it is best for you to neglect him and focus on the operations of your business.

In the book, Graham goes on to provide clear stock selection criteria for defensive and enterprising investors – with great examples to help stock evaluation practically. But more than those, the clear framework based on the above – definition of investment, asset allocation, the decision on type of investor, and the attitude towards market fluctuations – are most valuable for an individual investor to go about his investment operations.

Graham’s advice and wisdom are unlikely to make anyone rich in a hurry – perhaps only when one gets old. But the principles are timeless and practical, and unlikely to be available in such fullness anywhere else in today’s financial clutter. That alone makes it a case for the ‘best book about investing ever written’ in Warren Buffett’s words, to be a guiding light on your desk throughout your investing lifetime.

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We have met the enemy, and he is us: Are you being your own enemy?

April 22 is Earth Day – and this was the slogan used on a cartoon poster on the first Earth Day in 1970, with the character Pogo saying – “We have met the enemy, and he is us.” While it still holds true in the context of mankind being the earth’s biggest enemy due to multiple reasons, I think the statement is strikingly true even when it comes to investors.

In market crashes, there is this unending search for who is to blame for it, and multiple theories abound on whose actions led to it. Every time the reasons for the crash are different in terms of the context of the economy, from Harshad Mehta to Technology Dot-com boom to Sub-prime crisis, but the culprits blamed are many, and the enemy is still not to be found. Investors lose money, get out of the market thinking that I cannot find the enemy here, I do not understand this game, and I am not playing it – in most cases, not quite realizing that the enemy can often be found within themselves.

The biggest enemy of an investor is the investor himself. And that has got to do with the emotions of fear or greed, and a lack of a plan (or if it exists, a lack of discipline to adhere to it). The reality is that investment is less about which stocks will rise or which funds to buy, and more about what is your plan and whether you are willing to stick to it. If the investor focuses his attention away from the markets and more towards what his plan is, with respect to his goals, he is making every effort to ensure that he stops being his own enemy. A simple plan that is not dependent on market movements charted out to meet his goals, and the discipline to adhere to it through thick and thin are his best friends.

We all play games like cricket or monopoly – and most players or teams will increase their chances of winning if they have a plan and stick to it. Some times one will have to make slight changes when unexpected things happen and your ability to withstand pressure will matter then, but the importance of a plan and sticking to it cannot be undermined and is paramount. For example, for a game of cricket, you may have a plan to go for the slog in the first 15 overs and then consolidate your position for the next 25 with wickets in hand, and then go for the kill in the last 10 overs. You may lose a few wickets more than expected, and have to modify the plan a bit, but if you still manage to hold on to the plan, you are more likely to reach your target. Or in monopoly, the plan is simply to buy sites, houses, exchange them for hotels, and wait for people to land there and keep paying you rent or buying it from you – so that you get rich. You may get unlucky, and someone else might get the prized sites sometimes, but there is a clear plan to take if you want to win.

In the investment markets, the reason most people are their own enemies is because they do not have a clear plan. So the answer is simple – figure out what strategy or strategies work best for you given your goals, make a plan around them, and have the discipline to stick to that plan. Market prediction becomes irrelevant when an investor has a plan prepared. Market movements help him then only to the extent of assessing if any actions are needed in the context of his plan when the movements happen – and in most cases, irrespective of whether they are up or down – they are likely to be more than welcome for the investor. The search for an enemy will then reduce, as he is likely to see none!

How to handle volatility: Creating a mindset

I have often  found that for an individual investor, the toughest thing to deal with in stock markets is volatility. And by volatility – though it means fluctuations on both sides, what is tough to deal with is basically crashing stock prices. Financial theories have often equated risk to volatility – which may have some sense when you have a need to regularly evaluate the value of your portfolio, but is perhaps otherwise meaningless for an individual investor.

handlingvolatility

The all encompassing mindset of an individual investor has to be that of preparation for crashes. While investing in the stock markets, be it through mutual funds or directly, the dominant mindset needs to be that of being prepared for at least a 30% cut at any point in time. That mindset prepares you better to deal with it when it comes.

The advantage of such a mindset is to ensure some degree of rational thinking when the crash happens, even though there may be butterflies in the stomach. Inevitably that happens. In such a scenario, I have found the Ben Graham corollary of thinking of the stock market as an emotional guy called Mr Market whose moods keep fluctuating to be most valuable. This moody guy comes up everyday and offers you a price for your businesses. You are free to buy from him, or sell to him at that price whenever you want; and best of all, you are free to ignore him if you choose to. He will still come back tomorrow. Getting these two things into your mindset – that of expecting crashes, and thinking of stock markets as an emotional guy Mr Market – are the basic starting points in your battle against volatility.

Let’s say you manage to do that – the toughest task of all. After that, deciding what to do when stocks crash becomes easier. And that depends on largely whether you have a plan on why you are in the markets in the first place. If you have, then you are likely to do whatever makes sense according to that plan. If you do not, then this crash could be a good opportunity to do so. In both cases, you are likely to be in a better position to then decide whether to buy from Mr Market, sell to him or simply ignore him.

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