Warren Buffett is widely considered one of the greatest investors of all time, but if you were to ask him whom he thinks is the greatest investor, he would probably mention one man: his teacher, Benjamin Graham. Graham was an investor and investing mentor who is generally considered the father of security analysis and value investing. In this article, we’ll condense Graham’s main investing principles and give you a head start on understanding his winning philosophy.
Principle #1: Always Invest with a Margin of Safety
Margin of safety is the principle of buying a security at a significant discount to its intrinsic value, which is thought to not only provide high-return opportunities, but also to minimize the downside risk of an investment.
Principle #2: Expect Volatility and Profit from It
Investing in stocks means dealing with volatility. Instead of running for the exits during times of market stress, the smart investor greets downturns as chances to find great investments.
Principle #3: Know What Kind of Investor You Are
Graham advised that investors know their investment selves. To illustrate this, he made clear distinctions among various groups operating in the stock market.
Active Vs. Passive
Graham referred to active and passive investors as “enterprising investors” and “defensive investors.”
You only have two real choices: The first choice is to make a serious commitment in time and energy to become a good investor who equates the quality and amount of hands-on research with the expected return. If this isn’t your cup of tea, then be content to get a passive ( possibly lower) return but with much less time and work. Graham turned the academic notion of “risk = return” on its head. For him, “Work = Return.” The more work you put into your investments, the higher your return should be.
In modern terms, the defensive investor would be an investor in index funds of both stocks and bonds. In essence, they own the entire market, benefiting from the areas that perform the best without trying to predict those areas ahead of time. In doing so, an investor is virtually guaranteed the market’s return and avoids doing worse than average by just letting the stock market’s overall results dictate long-term returns. According to Graham, beating the market is much easier said than done, and many investors still find they don’t beat the market.
Speculator Vs. Investor
Not all people in the stock market are investors. Graham believed that it was critical for people to determine whether they were investors or speculators. The difference is simple: an investor looks at a stock as part of a business and the stockholder as the owner of the business, while the speculator views himself as playing with expensive pieces of paper, with no intrinsic value. For the speculator, value is only determined by what someone will pay for the asset. To paraphrase Graham, there is intelligent speculating as well as intelligent investing – just be sure you understand which you are good at.
Reprinted: Daniel Myers, Investopedia