The Intelligent Investor

February 24, 2019 9 min 20 s

Background

Around 2014, after being recommended this book by numerous sources, I picked it up and gave it a read. Great books profoundly influence the way you think for the rest of your life. The Intelligent Investor is such a book. It challenged my initial ideas on investment, how to think about assets, and how to think about wealth. Contained within it are sound principles for first preserving what one has and then increase that pile of money safely with time. Benjamin Graham gave me the tools to navigate the waters of finance without making the big mistakes. This is not a book for how to make a quick buck from bitcoin or the next craze or fad. This is a book on careful and conservative thinking in making returns while considering many factors for oneself.

Disclaimer and Basics on Retirement

I am simply an enthusiastic lay person who happens to know some math, a fair bit of personal finance, and likes reading books on the topic of investing. Please do your own research and don’t ask me for specific advice about any companies, markets, etc.

I will not help you with individual financial stuff. Please do not ask. Consult with a fiduciary advisor with any specific question you have and make sure your 401k company is not screwing you over. Hint: Your 401k provider is probably screwing you over, watch The Retirement Gamble.

The Gist

The Intelligent Investor and Security Analysis are the only investment books I ever needed to read, all the others were further elaboration on Benjamin Graham’s points. I decided to do this book review because his principles to preserve wealth, reducing the amount of false positives, and truly invest for the long run 1 are timeless techniques. For the purposes of brevity, I will focus on what Benjamin Graham calls a Defensive Investor instead of the Enterprising Investor.

Intelligent investing is not about being the smartest person in the room, it is about following sound principles to their ends. An intelligent investor is someone who develops temperance, patience, and control. She is learned, meticulous in her reasoning, and defensive in her thinking. She becomes familiar with the major ideas in many fields related to investing. These fields include, but are not limited to: psychology, history, basic statistics, meditation, and human evolution. An intelligent investor has more in common with an endurance athlete than a superstar sports player, in this game consistency can beat talent in many cases.

One of the worst investors of all time is Sir Isaac Newton. I don’t think many people would consider him stupid, but he was a stupid investor.2

How does Benjamin Graham Define These Two Types of Investors?

Defensive investors are focused on preserving their investment capital first and foremost. Their goal is to limit their downside, not get astronomical returns or be the next Warren Buffett. These are typically indexers or people who buy into mutual funds like Vanguard.

Enterprising investors are willing to devote more time to managing their investments and executing on investment ideas. In short, they spend more time analyzing all the aspects of a business and get to know it thoroughly. These are the investors who are trying to make higher returns over longer periods of time. Perhaps not becoming billionaires, but they focus on becoming significantly wealthier than your average joe.

When is it a Good Point to Become an Investor?

Everyone can be a mix, but taking big risks when you’re in debt or living hand to mouth is flirting with disaster. The money used for investing is money set aside for this purpose after all your other needs have been met and you’re safe.

Benjamin Graham doesn’t go into a ton of detail on when to start investing but here is a reasonable list:

You have to have no debt at all, when I say that I mean: car payments, student loan debt, more than monthly credit card payments, an unmanageable mortgage. Debt can be defined as owing any entity money.
Make sure you have a stable income source with excess money to use: jobs, side hustles, social security, winnings from law suites, etc.
Do you have a safety net of between 6 - 12 months of living expenses saved up? When the shit goes down you better be ready.

Why Am I Focusing on Defensive Investors and not talking about Enterprising Investors?

Many people try, and typically fail, to beat the market averages for many reasons, but the reality is that most people think they’re above average3 when in fact that’s statistically impossible. Can YOU beat the market consistently for decades? You can try, but it is likely that you will fail due to sheer time required, temperamental and intellectual advantage within the market, and the element of markets becoming more efficient – particularly at the large capital end , i.e. companies in the S&P 500.

To truly beat the market over long time spans one has to have patience, extreme patience, and an ability to focus on the larger goal while keeping their emotions in check for decades. It is a slow, turbulent, and boring process for most. People like Warren Buffett, Joel Greenblatt, Charlie Munger, and Ray Dalio are not just rare, they’re exceptional in ways beyond just mental powers that we can measure, like IQ.

Note: I included a link at the bottom to the subject of Dysrationalia, it is a fascinating topic and one that has no received enough attention in the psychology community.

If you read Vanguard’s The Case for Index Funds you will realize most “experts” are nothing more than highly paid money managers who on the whole detract from your portfolio returns by “managing” them when a simple index fund would beat 80%+ of these managers. This is the evil twin of compounded return, compounded loss. " But wait “, you say, " what about the other ~20+% of managers, why don’t I just go with them? “. That group is not a consistent batch of people so how are you supposed to pick the best fund managers if they don’t even know who they are?

Consider 1000 people trying to guess a coin toss.
Lets say half guess heads and the other half guess tails.
This keeps happening so 500 people are left,
then 250, 125, etc. until only one person is left.

Is this person an oracle? Do they have some amazing insight beyond mere mortals? No, they are the last person because that’s just what happens when you have so many rounds. What if you keep testing this person without others to elimination, I can almost guarantee you after a large amount of coin tosses it will become clear they cannot guess better than the average person. To extend the same logic here, managers who are “lucky” are no better than average most likely. They are simply “lucky” on the average. However, people who consistently show the ability to predict companies and market movements exist, but it is highly unlikely you are one without a track record. These people are called Super forecasters and it’s a fascinating subject but out of scope.

Have I talked you out of trying to beat the market yet? If not, consider the stress of pursuing a investment almost full time. You will need to constantly look for valuable companies, second guess yourself constantly, fail, retry, and in the end what if it turns out you just putting that money in an index would have outperformed all your wasted effort by doing literally nothing after investing the money? Wouldn’t that be a horrible feeling? From just an emotional and social perspective you would sacrifice so much with such a high likelihood of failure knocking at your door every day. The market enticing you constantly will noise about hot new companies and ideas, you would have to constantly pour over the companies for a single needle in a haystack of companies looking for just a single one that’s a good company that’s undervalued, well managed, has an economic mote, etc. Does that sound like how you want to spend every working hour or most of your free hours? For most of you, I don’t think so.

The defining Principles of Intelligent Investing

Invest for profits over time, not for quick buy and sell transactions.
Have confidence in your own reasoning [ so simply don’t follow the crowd].
Choose investments for their fundamental value, not for their popularity.
Understand the business you’re investing in.
Know the key people running the business.
Always invest with a margin of safety.

Intelligent investors, according to Benjamin Graham, are not magical ultra intelligent people, but simply people who have honed their ability to control their irrational fears and leave Mr Market alone.

Who is Mr. Market?

To put it simply, he is a hot mess of a person. You know that person who is always onto the next fad? Never learns a darn thing and is constantly thinking in terms of all or nothing? The dude has no damn nuance. He is the vice of the market, all the irrational greed, hubris, fears, and general excesses that the stock market experience day in and day out. He is the personification of all these things and he comes knocking on your door everyday with lots of “hot” stocks, bonds, etc. offering them to you at different prices. Sometimes his prices are sensible and other times they’re wacky. Why would you listen to a darn thing Mr. Market says about these companies? The latest news, hot speculation, whatever else. It takes him a long while to figure out what the value of a stock is. Don’t listen to this character, just wait for him to offer you a solid price after you have done your homework on what a company is worth.

So Mr. Market is a manic-depressive dude whose got some issues in the market, particularly the following:

1) Is emotional, euphoric, moody.
2) Is often irrational.
3) Offers that transactions are strictly at your option.
4) Is there to serve you, not to guide you.
5) Is in the short run a voting machine
in the long run a weighing machine.
6) Will offer you a chance to buy low, and sell high.
7) Is frequently efficient…but not always.

Who are Speculators?

People aren’t investors are speculators: focused on short term gains, growth stocks 4 , etc. They may make it big, but their path is more uncertain than the more consistent and conservative intelligent investors.

How do Defensive Investors Invest?

Well that’s complicated, JK! That’s the whole point silly willy, it’s supposed to be simple: 50% diversified bonds 50% stocks. What are bonds? What are stocks? The simple version is:

Stocks, yin: aggressive, lots of trading, high volatility <sup>5</sup>
shares of a business, theoretically higher returns over long periods of time.

Bonds, yang: stable, low frequency of trading, low fluctuations
in price in government debt, theoretically lower returns
over long periods of time.

Is that the full picture? No. Many options exist, here are some that I’d. Don’t like them? Read more and make your own. Not interested in that? Look into a target date funds.

Final Thoughts

Most of wallstreet is a casino and you are a player. The house always wins in the and if you are not wise and learn the rules of the game you will lose your money at any table. Who is the investor? Someone who is wise to the games and plays to win in the long game instead of gambling their winnings each time they play games with positive expected returns not noticing short term loses. Let the lucky gamblers have their day, for in the long game the investors always win.

Sources

1 Benjamin Graham’s definition of an investor: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

2 https://www.sovereignman.com/finance/how-isaac-newton-went-flat-broke-chasing-a-stock-bubble-13268/ Might be a myth, but it is mostly for illustrative purposes and doesn’t matter much whether it is true.

3 https://en.wikipedia.org/wiki/Lake_Wobegon

4 Amazon, Google, Facebook, etc. companies focused on expansion

5 Fluctuations in price