Hey!
This post presents the most important message from the book : “THE INTELLIGENT INVESTOR”. This book was proclaimed as “by far, the best book on investing ever written” by Warren Buffett (the most successful investor in the world).
So what is this important message in the book?
The message is that your investment strategy entirely depends on what kind of investor you are : Defensive or Enterprising.
Hence, the book suggests :
- You need to clearly understand what both of the terms mean.
- Then, decide what kind of investor you want to be : Defensive or Enterprising.
- Finally, take the corresponding course of action.
Lets look at the each of these three parts in this post.
1. The kind of investor : Defensive or Enterprising
Benjamin Graham, the author of the above-mentioned book and guru of Warren Buffett, writes :
“We make a basic distinction between two kinds of investors — the “defensive” and the “enterprising“. The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than average.”
In other simple words, there are two ways to be an investor :
- Enterprising : By continuously researching, selecting and monitoring the “best” available stocks and bonds. This takes time and energy. It is physically and intellectually demanding.
- Defensive : By creating a permanent portfolio that runs on autopilot and requires no further time or effort. This requires emotional detachment and a lot of discipline.
Finally, on this Graham writes,
“Over many decades an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort, in the form of better than average return realized by an defensive investor.”
This for me was another one of the important lesson in the book. Typically, when you read investment books, they mention:
Reward is proportional to the risk you are willing to take.
But that is an incomplete picture, the correct answer according to Graham is:
Reward is proportional to the risk you are willing to take, and also to the extra effort that are you willing to put in.
2. What kind of investor are you?
Enterprising : Sounds easy, but its not!
I am sure many of you reading this blog are pretty savvy, smart and intelligent. After reading the previous section, most of you are thinking that you are ready to flex your intellectual muscles. You are ready put in that extra effort and energy, and attain that “worthwhile reward” Graham mentions in his book.
HOLD YOUR HORSES!
It is not so easy and I can bet my money that 99% of you reading this underestimate the effort it takes to be an “enterprising” investor. To confess, in the beginning I also wanted to be an “enterprising” investor. I was ready to put in effort and gain that reward that I thought was rightfully mine. But the more I read, the more I realized how hard it is.
The following sentences will give you glimse on the effort involved. At a minimum, an enterprising investor should be willing to carefully read through at-least 5 years worth of proxies, very long quarterly reports and boring financial statements of different companies (at least 100 or so companies). Then you should be able to derive typical finance numbers out of those long reports and be able to do meaningful health compassion across different companies. Remember this is the L.E.A.S.T you would have to do!
If that sounds like a lot of work, it actually is and it is freaking hard! But still there are super-talented money managers in the world that aspire to be “enterprising” and they try this stuff anyway.
And do you know how many of this super-talented enterprising money managers beat the average market returns consistently 5
A surprising, and depressing 1% 2.
No, that is not a typo! Only 1% of the super talented guys beat the average market consistently. Even worse, if you account in the fees, that figure drops to 0.6%3.
99% of you are better off being defensive investors!
Being an enterprising investor is akin to opening a business enterprise, it needs knowledge, huge time and hell of an effort! So, for most of you reading this, you would be better off you identify yourself as a “Defensive” investor. I do not mean to be discouraging or blunt, but that is the fact.
If you are diligently saving your check (Good job, Hey!), and you want to invest it with minimal effort, annoyance and the best result : Go for the “Defensive” play!
3. Defensive investor : The course of action
Well this is easy! Some of the regular readers might have already guessed the answer that is about to come.
Benjamin Graham (The author of the book and The Guru) 4 and Warren Buffett (The Disciple) both strongly recommend Index funds as the best choice for a Defensive investor.
I already explained in detail about Index funds in my earlier post. Do read it if you have never heard about Index funds before. Here is a short version : Index funds own all the stocks in the market all the time, without any pretense of being able to select the “best” and avoid the “worst”. Amazingly, this beats most funds over long time.
So, the course of action action that defensive investors have to take is as follows. If your investment horizon (10-30 years) is long, then:
- Save as much as you can.
- Invest automatically every month a fixed amount (and whatever you can spare) in a low cost broadly-diversified index funds.
- Be diligent about this and do not time the market.
Do not get tempted to buy into that new sexy stock. Do not try to keep tampering the portfolio. Make a solemn commitment, that you would stick it for the long-haul and well then stick with it!
You could even take this to an another extreme level, as suggested by John C Bogle, a very famous and one of my favorite investors :
“For you retirement keep investing regularly in a total-market index funds irrespective of the market movements. Don’t peek [into your retirement statement]. Don’t open those statements until you retire. When you retire and open that statement, you are going to have so much money, you will probably go into dead faint.”
Bonus content : Is there a middle ground?
Many might be wondering if there is a middle ground between these two. Can I do a hybrid version? Let me quote Benjamin Graham again:
“Investment policy…depends in the first place on a choice by the investor of either the defensive (passive) or aggressive (enterprising) role. There is no room in this philosophy for a middle ground, or series of gradations, between the passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement.”
And this is my graphical take on those words:
Conclusion:
- There are two types of investors : Defensive and Enterprising.
- Your investing strategy depends on what kind of investor you are.
- Most of us fall under the category of defensive investors.
- The course of action for defensive investors is : Invest periodically in low cost well diversified index funds.
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Until the next time, Ciao!
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