There’s a business behind most investments. Graham’s last bit of wisdom in The Intelligent Investor points to this – investing makes you an owner (stocks) or a claimant (bonds) of a business. Your success is a product of the businesses ability to earn money and pay its debts.
In the age of index funds, I think it’s easy for investors to overlook this fact. They’re one step removed. They own shares of a fund. And because they own shares of a fund, the returns of said fund become more important than the performance of the businesses held by the fund.
It’s not much of stretch to conclude that a disconnect can lead to some poor decisions like selling an ownership in a basket of decent businesses – that, on average, earn money and grow earnings – because some fund’s shares bounced around too much.
To protect from this, Graham offered up four principles worth following. I won’t spend much time on each one – they’re fairly self-explanatory – but I think his principles are worth reviewing whenever your investing decisions become a bit too unbusinesslike.
Know what you are doing – know your business.
This is similar to one of Peter Lynch’s rules – “know what you own” – but Graham’s emphasis leans more toward aligning your expectations with reality.
Over time, your returns will mirror the performance of the business or basket of businesses you own (same goes for yield on a bond). Beating that performance is very hard. You can’t beat the average returns of a business unless you fully understand the business, know how to value it, and can pay less than its worth.
Do not let anyone else run your business, unless (1) you can supervise his performance with adequate care and comprehension or (2) you have unusually strong reasons for placing implicit confidence in his integrity and ability.
This one should be simple enough. If you’re going to let someone else invest your money, make sure that you understand what they’re doing, that it aligns with your goals, and that your best interests always come first.
Do not enter upon an operation – that is, manufacturing or trading in an item – unless a reliable calculation shows that it has a fair chance to yield a reasonable profit. In particular, keep away from ventures in which you have little to gain and much to lose.
For most investors the goal is to make money. In the process, they make the mistake of ignoring risk for the chance of a slightly higher return. For smart investors – the best investors seem to be proof of it – the real goal is to not lose a lot of money. Capital preservation is the core of their investment process.
Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgement sound, act on it – even though others may hesitate or differ. (You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.)
The market is a giant ball of contradiction to every investing strategy, idea, and theory. There is always something to worry about. There is always a reason not to invest. Waiting for better days is a bad investment strategy because it will never come.
At some point, you have to dive headfirst into the muck and take a position. You may not be right all the time, but if you’re following the first three principles, you’ll be right often enough to be successful. Graham expanded on it with this:
Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgement are at hand.