Edgar Lawrence Smith concludes his classic book with the importance of “Investment Management.” I don’t know how original this concept was in 1924, but investment management is exactly like it sounds. Anyone who’s read a few investing books should recognize the principles Smith lays out since it fits the basic concepts of investment planning today.
Obviously, the big difference between then and now is that most investors are analyzing funds or strategies instead of individual stocks and bonds. And analyzing might be an exaggeration.
Smith’s point falls under the Peter Lynch maxim of “Know what you own” and keep a watchful eye over it.
But first you need a sound plan. He lays out the case for management as an ongoing effort to balance a portfolio between stocks and bonds based on whatever the current environment warrants.
Then he expands into having a plan for the long term (including the next generation), the importance of diversification, and understanding the limits of what’s possible.
Here’s how Smith broke it down:
“Investment” implies a single act, and implies the exercise of sound judgment only at the time the investment is made. “Investment Management” is a continuing act and implies the continuous application of judgment. It includes the act of investment, but it also includes a great deal more.
A fund invested at a given time is entitled to a certain return under the conditions prevailing or to be foreseen at that time. A fund placed under competent investment management is entitled to this same return plus an additional return which is large or small in proportion to the degree of investment management that may be applied to it, and the ability of those who apply it…
Investment Management includes the function of establishing a just relation between that portion of income which may be safely spent, and that part which should be reinvested for the protection of this income and the enhancement of the fund, but its principal opportunity lies in appraising current economic and industrial conditions as they tend to affect the holdings of the fund…
Sound investment management takes these economic factors into consideration in determining at any given time what proportion of a fund should be in equities represented common stocks and what proportion should be in maturing obligations represented by bonds, and is vigilant to note changes in fundamental conditions which dictate a change in these proportions. but investment management goes further…
Sound investment management, while always subject to error, cannot fail to improve average investment results if the principal of diversification is strictly adhered to.
But diversification may be carried to excess. No investor nor group of men responsible for any investment fund can keep constantly informed regarding too long a list of securities representing too wide a variety of industries, locations and managements. There are well recognized limitations to the diversity of items upon which continuous judgment may be exercised. Better results are obtained when these limitations are admitted as facts.
We may, then, summarize the principal functions of Investment Management as follows:
- It will first establish a sound investment plan suitable to the purposes of the investor.
- It will then determine what proportion of the fund under its management shall be in equities and what proportion in bonds under current industrial and economic conditions.
- It will put itself in a position to watch for changes in conditions and be prepared to modify these proportions in harmony with such changes.
- It will study the current conditions of various industries and groups of industries, and will select as its field a diversification of those which upon reliable data may be regarded as the more promising.
- It will then examine the management and financial structure of the leading companies in these industries.
- It will watch for changes both in the conditions of industries and of individual corporations and be prepared to change the investment to accord with sound analysis of the latest available information.
- It will retain diversification as its fundamental principle, but will establish reasonable limitations to diversification in order not to dilute the quality of management applied.
This is no simple task. It is a task which each individual investor, responsible not only for his own welfare but for the welfare of those he is to leave behind him, must appraise in relation both to his own experience and training in a highly technical field and in relation to the amount of time and the facilities at his disposal to properly undertake it.