Benjamin Graham’s Three Principles of Value Investing
Have you read The Intelligent Investor and Security Analysis by Benjamin Graham? These two books are considered as must read for value investing, but they are all pretty heavy books, especially the Security Analysis. If you just want to grab the essentials of the books, then there’s on article on Forbes about Graham’s three timeless principles of investing.
1. Always Invest With a Margin of Safety
According to Investopedia, margin of safety is “a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value.” If the asset is worth $1, then Graham would buy the stock at $0.50. With the margin of safety in mind, investors buy stocks at discount to minimize downside risk.
This concept is very important for investors to note, as value investing can provide substantial profits once the market inevitably re-evaluates the stock and raises its price to fair value. It also provides protection on the downside if things don’t work out as planned and the business falters. The safety net of buying an underlying business for much less than it is worth was the central theme of Graham’s success. When stocks are chosen carefully, Graham found that a further decline in these undervalued equities occurred infrequently.
2. Expect Volatility and Profit From It
Measured by CBOE Volatility Index (VIX), the stock market is as volatile as it can be since last September. The investing strategies used by Graham to deal with market volatility, which are still valid today, are:
- Dollar-cost averaging: With DCA, you buy a fixed dollar amount regularly, taking advantage of dips of the market without having to worry about when to get in and out of the market. Though DCA has its limitation in an up market, it is proven to be the winning method in the long term.
- Invest in both stocks and bonds: Investing isn’t just about what assets to buy, but also how these assets are mixed in your portfolio based on a thorough evaluation of investing time horizon, risk tolerance, and expected returns, etc. Having the right asset allocation mitigates the risk.
3. Know What Kind of Investor You Are
Are you a passive investor (defensive investor) or active investor (enterprising investor)? Being an active investor requires a lot of hard work to achieve the kind of return that’s proportional to the effort. If you don’t have the time and energy to actively research on what to invest, then take the passive approach and accept market returns.
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.
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