I dug up a 1963 lecture by Ben Graham – titled Securities in an Insecure World (linked below) – that popped up online several years ago and thought I’d share a few notes.
In the lecture, Graham discusses three big dangers investors face – nuclear war, inflation, and severe market volatility (specifically drawdowns) – which are the same today. Then he branches off into behavior, market valuation, and asset allocation.
He points out a recurring theme that resurfaces every few years:
They are returning to the idea that for the smart investor the question of stock market fluctuations does not have to be considered to any great extent. There is a two-fold emphasis here, which slurs over the reality of stock market fluctuations. The first is the general conviction that the market can be counted on to advance so emphatically through the years that whatever declines take place are comparatively unimportant; hence if you ahve the true investor’s attitude you don’t have to concern yourself with them. The second claim is a denial that the “stock market” exists at all, meaning thereby that what the market averages do is of no real importance to the intelligent, well-advised investor or speculator. It seems to be a ruling tenet on Wall Street that if you practice the proper kind of selectivity in investments you don’t have to worry about what the stock market does as a whole, as shown by the averages, for at all times the good stocks will be going up adn the bad ones will be going down and all you need to do is pick the good stocks and forget about the stock market averages.
The first one – the argument that common stocks are and always will be attractive, including present time, because of their excellent record since 1949 – involves in those terms a very fundamental and important fallacy. This is the idea that the better the past record of the stock market as such the more certain it is that common stocks are sound investments for the future…But you cannot say that the fact that the stock market has risen countinously (or slightly irregularly) over a long period in the past is a guarantee that it will continue to act in the same way in the future. As I see it, the real truth is exactly the opposite, for the higher the stock market advances the more reason there is to mistrust its future action if you are going to consider only the market’s internal behavior. We all know that for many decades the typical history of the stock market has been a succession of large rises, in good part speculative, followed inevitably by substantial falls…Hence, a large advance in the stock market is basically a sign for caution and not a reason for confidence.
The best way to deal with market volatility is to prepare yourself mentally for wide swings in prices at any time and adjust your asset allocation – between stocks and bonds – based on changes in market valuation.
In my nearly fifty years of experience in Wall Street I’ve found that I know less and less about what the stock market is going to do but I know more and more about what investors ought to do; and that’s a pretty vital change in attitude. The first point is that the investor is required by the very insecurity ruling in the world of today to maintain at all times some division of his funds between bonds and stocks…Any such variations should be clearly based on value considerations, which would lead him to own more common stocks when the market seems low in relation to value and less common stocks when the market seems high in relation to value.
Now while this is the classic language of investment authorities, it is amazing how many people think in exactly opposite terms.
Graham goes on to recommend a minimum and maximum allocation between 25% and 75% respectively for stocks and the opposite for bonds (along with rebalancing and dollar cost averaging). The point is to avoid the all or nothing allocation.
The main need here is for the investor to select some rule which seems to be suitable for his point of view, one which will keep him out of mischief, and one, I insist, which will always maintain some interest in common stocks regardless of how high the market level goes. For if you had followed one of these older formulas which took you out of common stocks entirely at some level of the market, your disappointment would have been so great because of the ensuing advance as probably to ruin you from the standpoint of intelligent investing for the rest of your life.
Investing is an art, not a science. It’s impossible to consistently predict when the market turns. Owning a little bit of something guarantees you won’t miss out in case your wrong, or have much on the line in case your right, but the market hasn’t realized it yet.
The investor must recognize that there are uncertain and hence speculative elements inherent in any policy he follows – even an all-Government-bond program. He must deal with these uncertainties by a policy of continous compromise between bonds and common stocks, and by adequate diversification…He must make a strong effort to have more money invested in common stocks at lower market levels than at what he recognizes to be potentially high levels. Most important, he must maintain a philosophical attitude towards the inescapable variations in his financial position and the inevitable “mistakes” associated with these varations.
Source:
Graham Lecture: Securities in an Insecure World
