SummaryChapter4GeneralPortfolioPolicy:TheDefensiveInvestor
NotesonTheIntelligentInvestorbyBenjaminGraham
NotesbyJasonFernando
CreatedNovember20th2013
LastupdatedNovember20th2013
Referencedocument:Graham,Benjamin,andJasonZweig.TheIntelligentInvestor.Rev.ed.New
York:HarperBusinessEssentials,2003.
50WordRecap
Moreriskdoesnotnecessarilyimplymorereward.Rather,rewardincreasesinlinewiththe
intelligenteffortbroughttobearbytheinvestor.
Defensiveinvestorsshoulddividetheirfundsbetweenhighgradebondsandhighgrade
commonstocks.
Inselectingbonds,investorshaveanumberoffactorstoconsider.
Grahamnotes,thenrefutes,acommonnotion:Generally,peoplespeakofaratiobetweenriskand
returnwhereinincreasedriskisassociatedwithahigherexpectablerateofreturn(wewillhereignore
thefactthat,insospeaking,oneimplicitlyignorestheequalandoppositesideoftheequation).Inthis
manner,peoplespeaksuchnotionssuchasthattherateofreturnwhichtheinvestorshouldaimforis
moreorlessproportionatetothedegreeofriskheisreadytorun.
1
Ourview,heparries,isdifferent.
2
Therateofreturnsoughtshouldbedependent,rather,ontheamountofintelligenteffortthe
investoriswillingandabletobringtobearonhistask.
Accordingly,Grahamsetsoutrecommendationsfortwodistinctclassesofinvestors:The
defensive,orpassiveinvestor,whovaluesconvenienceandsecurityaboveprospectivesuperior
resultsandtheenterprisinginvestor,whohasthetime,competence,andinclinationtodelvedeeper
intotheartofinvestinginpursuitofincreasedperformance.
Therecommendationsofthischapterareforthedefensiveinvestor.
1
88.
2
Ibid.
TheBasicProblemofBondStockAllocation
ThebasicprinciplewhichshouldguidethedefensiveinvestoristhatHeshoulddividehisfunds
betweenhighgradebondsandhighgradecommonstocks.
3
Tothis,Grahamaddsthat[he]shouldneverhavelessthan25%ormorethan75%ofhisfunds
incommonstocks,withaconsequentinverserangeofbetween75%and25%inbonds. Asageneral
4
rule(i.e.barringsignificantperceivedpriceimbalances)thestandarddivisionshouldbeanequalone,
or5050,betweenthetwomajorinvestmentmediums.
5
TheProblem
TheapproachwhichGrahamoutlinesabovemakesperfectsenseintheory,butisnotoriously
difficulttoimplementinpractice(Or,inhiswords,Thesecopybookmaximshavealwaysbeeneasyto
enunciateandalwaysdifficulttofollow ).Thisisnotbecauseofanyextraneousortechnological
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factors,butratherbecauseofthehumanfactor:Onesownindividualpsychology.Itisexceedingly
difficulttorefrainfrombuyingsecuritieswhenthepriceofthosesecuritiesisadvancingconversely,itis
equallydifficulttorefrainfromsellingsecuritieswhentheirpriceisindecline.However,itisprecisely
thisrestraintwhichisnecessaryforonetoavoidfallingintotheperiloustrapofbuyinghighandselling
lowthatcounterproductiveinstinctwhichisattheheartofmassmarketbehaviour.Thetrick,Graham
argues,istoprofitfromthatirrationalitynotcontributetoit.
TheBondComponent
Withregardtothebondcomponentofherportfolio,shouldtheinvestorbuytaxableor
taxfreebonds?Shortertermorlongertermmaturities? Thesearethefourprincipalquestions
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whichtheinvestormustaskherself.
Taxableortaxfree?
Thetaxdecisionshouldbemainlyamatterofarithmetic,turningonthedifferenceinyieldsas
comparedwiththeinvestorstaxbracket.
8
3
89.
4
Ibid.
5
Ibid.
6
89.
7
91.
8
9192.
WhentoBuyTaxableBonds WhentoBuyTaxFreeBonds
Ifthetaxliabilityincurredontaxespaidonthe
taxablebondswillbelessthantheincreasedyield
offeredbythetaxablebondsrelativetotaxfree
alternatives.
Inotherwords,iftheyieldontaxablebonds
morethancompensatesfortheirtaxliability.
Ifthetaxliabilityincurredontaxespaidonthe
taxablebondswillbegreaterthantheincreased
yieldofferedbythetaxablebondsrelativeto
taxfreealternatives.
Inotherwords,iftheyieldontaxablebonds
doesnotcompensatefortheirtaxliability.
Shortertermorlongertermmaturities?
Thechoiceoflongerversusshortermaturitiesinvolvesquiteadifferentquestion,viz.:Doesthe
investorwanttoassurehimselfagainstadeclineinthepriceofhisbonds,butatthecostof(1)
alowerannualyieldand(2)lossofthepossibilityofanappreciablegaininprincipalvalue?
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(Emphasisadded).
WhentoBuyShorterTermMaturities WhentoBuyLongerTermMaturities
Whenonevalues(generally)decreased
probabilityofdefaultmorethanannualyield.
Whenoneanticipatesthatinterestrateswill
riseinthemediumandlongterm.
Whenonevalueannualyieldmorethan
(generally)decreasedprobabilityofdefault.
Whenoneanticipatesthatinterestrateswill
fall.
9
92.
