The Best Investment Portfolio | Graham’s Portfolio
Few people in the past century could arguably be as influential as Benjamin Graham when teaching and applying sound investment principles. He is widely known as a father of value investing. Luckily, he distilled most of his investment philosophy in two highly respected books: Security Analysis (with David Dodd) was published in 1934, and The Intelligent Investor in 1949. One of his most successful students and early partners was Warren Buffett. In the intelligent investor, Graham identified two main approaches: one for the “defensive investor” (passive investor) and one for the “enterprising” (active) investor.
Graham’s advice depends less on what kinds of investments we own than on what kind of investors we are. Do we like to research, select, monitor, or prefer a permanent portfolio requiring no effort? The first approach takes a lot of time and energy, while the second requires a certain ascetic detachment from the alluring “opportunities” of the market. Graham believes in the importance of identifying the right approach for us and sticking with it: investment risk lies not only in the external market but also within ourselves. As such, we must select and stick to a manageable approach aligned with our attributes. Graham strongly differentiates between investment and speculation. He acknowledges that investing in stock holds some speculative operations; however, an investment operation is one which, upon thorough analysis, promises the safety of the principal and an adequate return. While an investor judges the market price by establishing intrinsic value standards, the speculators base their standard values upon the market price. For Graham, investors should hold stock only if they are comfortable, not knowing its daily share price. For Graham, speculation can be exciting and rewarding at times. Still, it is ultimately the worst way to build wealth: Wall Street, like Las Vegas or the race tracks, has calibrated the odds so that the house always wins against everyone who tries to beat it.
THE DEFENSIVE INVESTOR
For Graham, a Defensive Investor should divide his funds between high-grade bonds and high-grade common stock. He is convinced that the Defensive Investor is better off by sticking to a 50-50 allocation and rebalancing the portfolio when changes in the market levels raise one of the two components. He acknowledges that it may not turn out to be the best portfolio in terms of results achieved. Still, it would satisfy the conservative investor for any gain on half of his portfolio during a rising market (thanks to the stock component) while providing solace during severe market declines (thanks to the bond component’s stability). The bond is a cushion that will give them the courage to keep the rest of the money in stock even when the market is not performing well. However, this approach is still emotionally demanding: it still requires keeping emotions under control by simply automating any required re-balancing without extra actions. The key is to rebalance on a predictable, patient schedule, like every six months.
- Graham indeed considers the possibility of a defensive investor to increase the stock component. He states that an investor can try to take advantage of a long-term bear market that offers stock at bargain prices. In such cases, he still suggests keeping stock within 75% of the total portfolio and being ready to re-balance it. A 25% bond component is the minimum limit to guarantee a sufficient balanced portfolio and mitigate volatility for a Defensive Investor.
- It is worth mentioning that in 1949 common stock was generally viewed as highly speculative and, therefore, unsafe. Graham’s advice to include common stock in any defensive portfolio was, therefore, more innovative than it looks today. Graham promoted common stock as a hedge against inflation and for its higher average returns over the years. Once bought at the right price, the defensive investor cannot afford to be without an appreciable proportion of common stock. Even if he must regard it as the lesser of two evils, the greater the risk attached to an all-bond holding.
- Like most of the managers of large funds, the investor does not have the ability to get better than average results. Graham indicates that the Defensive Investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial conditions and avoid “hot” offerings.
- Graham suggests using the dollar-cost averaging method and constantly investing the same amount of money each month/quarter. This approach will secure buying more shares when the market is low and fewer shares when the market is high: this approach will guarantee a satisfactory price of Assets in the long run.
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