Friday, April 2, 2010

The Intelligent Investor (Part 1): Intro and Defensive Investor

Warren Buffett calls Benjamin Graham's "The Intelligent Investor" by far the best book on investing ever written. So who am I as a lay investor to not take the advice of an investor master or the master's teacher. As always, I went to the local library and found the book I was looking for. Of course, I wasn't looking for it at all, but just wanted to update myself on the latest trends, strategies, philosophies, thoughts on the market. I ran across Old Ben's book and since it has withstood the test of time, I had no choice but to borrow it and break it open. I hope the next few posts would be enlightening, educational, and bring about a greater awareness of some of the things that Ben Graham and his disciples emphasize.

The Intelligent Investor can be broken down to two different types of investors: a passive type and a more active type. Graham calls the passive type the Defensive Investor and the more active type the Enterprising Investor.

In any case, Intelligent Investors have these traits:

- They see stocks as business - when you buy a stock you become an owner of that company
- They recognize two basic patterns the market has in unsustainable optimism and unjustified pessimism - both extremes are wrong so maintain a level head during bubbles and crashes
- They understand future value is a function of present price - the higher price you pay, the lower the return you will be
- They maximize margin of safety - never overpaying for a stock and reducing risks
- They develop discipline and courage - recognizing that your biggest enemy is yourself and not to be swayed by the market or other people's moods. You decide your fate.

For the Defensive Investor, after pouring through years and years of financial data, Graham suggests a 50/50 rule. 50% in bonds and 50% stocks. Putting the stocks in an index fund or a group of value stocks with a constant investment over a long period of time will get you better than average results. This is the lazy, boring, passive way. By using dollar cost averaging, you ride through both bubbles and crashes. You buy on the way up and on the way down. You are constant in the midst of the crazy waves of the market.

Table 3-2 (p71) Graham looked at S&P (a cross section of the stock market) at a decade by decade performance from 1871-1970. The table showed tremendous growth along with a few decades of decline (1930-1940), but overall this showed that even a passive investor can make a good return on investment by having a disciplined savings plan over a long period of time.

But to the more active investor, what can he/she do to beat the market?

We'll continue in the next post.

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