6. Chapter 1: investment versus speculation
In this chapter he outlines the viewpoints in the rest of the book, especially the viewpoints about the development of a portfolio policy which is suitable for the layman.
6.1. The difference between investment and speculation
In investment operations, the investor first does a thorough analysis, leading to safety of principal (the principal is the original sum invested) + an adequate return. Any other kind of operation is a speculative operation, and the person who does it is a speculator.
Nowadays, in the media and even in the universities, this difference is not highlighted, and this is a cause for concern. (Lyle’s note: maybe a lot of people in the media and in the universities don’t even understand the difference?)
Graham writes, “Outright speculation is neither illegal, immoral, nor (for most people) fattening to the wallet. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone.” In the same way as there is “intelligent investing”, there can be “intelligent speculating”. However, there are many ways in which speculating can be unintelligent:
a. speculating when you think you are investing
b. getting involved in serious speculating when you lack the proper knowledge and skill
c. risking more money in speculating than you can afford to lose.
If you really feel you HAVE to speculate, then set aside a SMALL amount of your capital for speculation in a separate “speculation account”.
6.2. Recommended portfolio policies for the defensive investor
The recommended policy was mentioned already in the Introduction, it is a mixture of:
. leading shares
and
. bonds (or similar financial instruments)
Graham says that a general principle should be that the amount of bonds should not be less than 25% and not more than 75%. He then makes it clear that the amount of each ingredient in the mixture depends on the current market situation, and suggests two policies about the mixture:
a. Simplest policy
The amount of bonds should be 50% and the amount of shares should be 50%.
b. Alternative policy
The amount of shares should be reduced to 25% when the market is dangerously high, and the amount of shares should be increased to 75% when the market is attractively low.
6.3. Three more concepts for the defensive investor
Investment funds (see Chapter 9)
Investment advisors (see Chap. 10)
Dollar-cost averaging (see Chap. 5).
The last one is the most highly recommended. It means buying the same value of shares every month for a period of years. This balances out the fluctuations in the market.
6.4 Zweig on Chapter 1
The intelligent investor never dumps a stock just because the share price has fallen. The only reason to do this is if the value also falls.
7. Chapter 2: the investor and inflation
Graham suggests precious metal investment trusts and gold as a hedge against inflation.
Zweig suggests property investment trusts and inflation-linked goverment securities
8. Chapter 3: A century of stock-market trading
(Lyle’s note: this chapter is a very long historical analysis of the US stock market over a period of many years. I won’t summarise it).
9. Chapter 4: the defensive investor
TRUE: “If you can’t afford to take risks with your investments, you will have to be content with a relatively low return”.
FALSE: “The rate of return is proportional to the risk”
TRUE: “The rate of return is proportional to the intelligent effort that is put into the investment operation”.
Graham now returns to his recommended policy for the defensive investor: 50% Bonds (or similar) and 50% blue-chip shares. He says the following are the advantages of this “50-50 policy”:
a. extremely simple and easy to understand
b. it definitely aims in the right direction
c. it gives the investor the feeling that he is taking some action in response to market fluctuations
d. most importantly, it restrains him from being drawn more and more heavily into a shares when the market is dangerously high
e. provides satisfactory gains from half of the portfolio in a rising market and limitation of potential losses in a falling market.
f. (Zweig) it will give you the courage to hold on to the share part of the portfolio is prices plummet.
9.1 The bonds in the portfolio
Bond investors can choose between:
a. tax-free and taxable bonds
b. short-term and long-term bonds
c. High-grade and low-grade (junk bonds)
Junk bonds give a high yield, but Graham doesn’t recommend them (too risky). Zweig says this risk can be reduced nowadays by investing in a junk-bond fund.
d. (Zweig) bonds themselves and bond funds.
Zweig says that bond funds are a more recent way of investing in bonds, and he recommends them because:
a. there is normally no “minimum investment” restriction
b. they provide cheap and easy diversification in the bond part of the portfolio
c. they provide a convenient monthly income, or you can accumulate the earnings automatically.
9.2 Other similar investments
US Treasuries (Lyle’s note - In the UK: Gilts and War Loan); Corporate bonds; non-convertible preferred shares (not suitable for the private investor)
9.3 Zweig on Chapter 4
FALSE: “The size of the share component in the portfolio depends on age, so older investors should reduce the share percentage, and young investors can increase the share percentage”.
e.g. a 25-year-old who is saving for his wedding and the down-payment on his first house would be crazy if he invested 100% in shares.
In this chapter he outlines the viewpoints in the rest of the book, especially the viewpoints about the development of a portfolio policy which is suitable for the layman.
6.1. The difference between investment and speculation
In investment operations, the investor first does a thorough analysis, leading to safety of principal (the principal is the original sum invested) + an adequate return. Any other kind of operation is a speculative operation, and the person who does it is a speculator.
Nowadays, in the media and even in the universities, this difference is not highlighted, and this is a cause for concern. (Lyle’s note: maybe a lot of people in the media and in the universities don’t even understand the difference?)
Graham writes, “Outright speculation is neither illegal, immoral, nor (for most people) fattening to the wallet. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone.” In the same way as there is “intelligent investing”, there can be “intelligent speculating”. However, there are many ways in which speculating can be unintelligent:
a. speculating when you think you are investing
b. getting involved in serious speculating when you lack the proper knowledge and skill
c. risking more money in speculating than you can afford to lose.
If you really feel you HAVE to speculate, then set aside a SMALL amount of your capital for speculation in a separate “speculation account”.
6.2. Recommended portfolio policies for the defensive investor
The recommended policy was mentioned already in the Introduction, it is a mixture of:
. leading shares
and
. bonds (or similar financial instruments)
Graham says that a general principle should be that the amount of bonds should not be less than 25% and not more than 75%. He then makes it clear that the amount of each ingredient in the mixture depends on the current market situation, and suggests two policies about the mixture:
a. Simplest policy
The amount of bonds should be 50% and the amount of shares should be 50%.
b. Alternative policy
The amount of shares should be reduced to 25% when the market is dangerously high, and the amount of shares should be increased to 75% when the market is attractively low.
6.3. Three more concepts for the defensive investor
Investment funds (see Chapter 9)
Investment advisors (see Chap. 10)
Dollar-cost averaging (see Chap. 5).
The last one is the most highly recommended. It means buying the same value of shares every month for a period of years. This balances out the fluctuations in the market.
6.4 Zweig on Chapter 1
The intelligent investor never dumps a stock just because the share price has fallen. The only reason to do this is if the value also falls.
7. Chapter 2: the investor and inflation
Graham suggests precious metal investment trusts and gold as a hedge against inflation.
Zweig suggests property investment trusts and inflation-linked goverment securities
8. Chapter 3: A century of stock-market trading
(Lyle’s note: this chapter is a very long historical analysis of the US stock market over a period of many years. I won’t summarise it).
9. Chapter 4: the defensive investor
TRUE: “If you can’t afford to take risks with your investments, you will have to be content with a relatively low return”.
FALSE: “The rate of return is proportional to the risk”
TRUE: “The rate of return is proportional to the intelligent effort that is put into the investment operation”.
Graham now returns to his recommended policy for the defensive investor: 50% Bonds (or similar) and 50% blue-chip shares. He says the following are the advantages of this “50-50 policy”:
a. extremely simple and easy to understand
b. it definitely aims in the right direction
c. it gives the investor the feeling that he is taking some action in response to market fluctuations
d. most importantly, it restrains him from being drawn more and more heavily into a shares when the market is dangerously high
e. provides satisfactory gains from half of the portfolio in a rising market and limitation of potential losses in a falling market.
f. (Zweig) it will give you the courage to hold on to the share part of the portfolio is prices plummet.
9.1 The bonds in the portfolio
Bond investors can choose between:
a. tax-free and taxable bonds
b. short-term and long-term bonds
c. High-grade and low-grade (junk bonds)
Junk bonds give a high yield, but Graham doesn’t recommend them (too risky). Zweig says this risk can be reduced nowadays by investing in a junk-bond fund.
d. (Zweig) bonds themselves and bond funds.
Zweig says that bond funds are a more recent way of investing in bonds, and he recommends them because:
a. there is normally no “minimum investment” restriction
b. they provide cheap and easy diversification in the bond part of the portfolio
c. they provide a convenient monthly income, or you can accumulate the earnings automatically.
9.2 Other similar investments
US Treasuries (Lyle’s note - In the UK: Gilts and War Loan); Corporate bonds; non-convertible preferred shares (not suitable for the private investor)
9.3 Zweig on Chapter 4
FALSE: “The size of the share component in the portfolio depends on age, so older investors should reduce the share percentage, and young investors can increase the share percentage”.
e.g. a 25-year-old who is saving for his wedding and the down-payment on his first house would be crazy if he invested 100% in shares.