Book of the month - Intelligent Investor by Benjamin Graham

Ladies and gents I wish you happy 2024! 🎊🥂

I hope that you spend your last day and night in a great company. And that today’s hangover isn’t too bad.

I also hope that this is the first newsletter in your inbox this year and that it will give you a nice encouragement to start your new year in the right way.

By intelligently investing your time and money!

Without further ado - let me present you the recap of December 2023 book of the month.

Enjoy and I’ll be with you with the first nugget of 2024 financial wisdom in just 2 days. #everywednesday

First a bit about the book. The first iteration of the book was written back in 1950. Since than it has been updated and rewritten a couple of times, but the basic principles are still applicable today.

Warren Buffet (one of the most successful investor of our time) has quoted it many times and says till this day, that it’s still the best book he read on investing. And if he says it, it must be true.

He also wrote a preface and I liked one paragraph so much, that I want to put it here word by word:

Similar to the book of past month, he points out that investing and other money related skills are way more related to psychology than intellect or even math skills. I think that is very important because I know women often think, that they do not know enough to handle their finances. And that is something I want to change with this newsletter as well.

What makes an Intelligent Investor?

The Intelligent Investor is a realist who sells to optimists and buys from pessimists.

The market always swings between two sides - unsustainable optimism (which makes stocks too expensive and more risky) and unjustified pessimism (which makes them too cheap ans less risky). The higher the price you will pay, the lower your return will be. Graham says, as Buffet pointed out, that the secret to your financial success is inside yourself.

He makes a point to differentiate between an investor and a speculator. He says that an investment is an operation, which upon analysis, promises safety of the principal and an adequate return. Operations not meeting these requirements is a speculation.

There are two types of investors according to him. The defensive (passive) and the enterprising (active). Defensive strives towards avoidance of serious mistakes or loses. He does not want to put in too much effort and avoid making frequent decisions. The enterprising investor is prepared to devote time and care to the selection of stocks that are more attractive than the average ones.

In his book Graham talks about different relationships that money has with economic events, one of them being inflation.

One general truth is that if you have fixed income, inflation can cut into your budget. Holders of stocks or other assets that provide some passive income (dividends for example), may be able to mitigate the rising inflation.

Let’s talk about so called “money illusion” that often overshadows our view of money matters. If you receive a 2% salary raise and that same year inflation is 4%, you will for sure feel better, than if you take a 2% pay cut in a year where there is no inflation. Now if you do the math, you’ll see that you end up in the same place of -2%. We are wired in a way, that the change in our salary is more vivid, specific and close to us than the change of prices in the economy as a whole. That is why it is important to also consider the inflation when you measure your investing success.

One of the Graham’s arguments is, that the intelligent investor must never predict that things in the future, will go the same way as they did in the past. However, there are 3 factors that are always true, when it comes to stock market. It’s performance depends on:

• real growth - the rise of companies earnings and dividends

• inflationary growth - the general rise of prices throughout the economy

• speculative growth or decline - increase or decrease in the investing public’s appetite for stocks

General rule will always stay the same:

Many people stop investing because the stock market goes down or even worse - their first instinct is to bail their investment to “safety” when they are already in red. Instead of buying and holding their stocks, many people end up buying high, selling low and holding nothing but their own head in their hands instead of some extra money to fight the inflation.

Let’s start with a quote from a stoic philosopher:

I think that by now it is clear, that there is no one recipe for investing that everyone can follow. Even though you are investing in “Mr Market” as Graham likes to call it, you should not be always listening to his advice. 

Mr Market goes up one day like a lunatic and down the other, like there is no tomorrow. He comes in the morning screaming at you “sell sell” and “buy buy” at the end of it. Should you listen to this bipolar creature all the time? Of course not. You need to take control of your emotional and financial life and not let him dictate it.

However, you shouldn’t ignore him entirely. His job is to provide you the prices and your job is to decide whether it is to your advantage to buy at that specific time. You do not have to trade with him just because he constantly begs you to.

You can not control Mr Market. Investing intelligently is about controlling the controllable:

• your trading costs - picking a trading platform with low costs, trading rarely, patently

• your expectations - by using realism, not fantasy, to forecast your returns

• your risk - by deciding how much of it you are willing to take, by diversifying and rebalancing if needed

• your tax bills - important - to make sure you know the tax implications in your country and hold assets for longer period of time because often you can lower your taxes that way

• and most importantly - your behavior

But why is this sometimes harder than it seems?

It turns out that we are the problem. Well, out brain at least. Humans are pattern-seeking animals. Neuroscience has shown that our brain is designed to see trends, even if there aren’t any. If the stock goes up a few times in a row, your brain expects that it will keep going up. Your brain chemistry changes as the stock rises and it is giving you a “natural high”. You effectively become addicted to your own predictions.

When the stock price drops, the financial loss fires up your amygdala, which is the part of your brain that processes fear and anxiety. This then causes the “flight or fight” response and pushes us towards taking the money out of the market, when we are already in the red. Mistake.

In that moment you should remember - falling prices are good news, not bad, since your are able to buy more stocks for less money.

If your investment horizon is long - at least 25 to 30 years - there is only one sensible approach:

To be an intelligent investor, you must also not compare yourself to others because - comparison is the thief of joy. In all areas of life. It’s your life that you are living, not others. Also, no one’s gravestone reads “She beat the market”.

The whole point of investing is not to earn more money than average, but to earn enough money to meet your own needs. In the end, what matters isn’t crossing the finish line before anybody else, but just making sure that you do cross it.

To be an intelligent investor, you must take the responsibility for ensuring that you never lose most or all of your money. Losing some money is an inevitable part of investing and there is nothing you can do to prevent it. But how can you be cautious to avoid losing a lot of money? By refusing to pay too much for an investment.

The risk in not in the stocks, but in ourselves. If you underestimate how well you really understand an investment or you overestimate your ability to ride out a temporary plunge in prices, it doesn’t matter what you own or how the market does.

And it all comes down to the decisions you make. According to Nobel-prize-winning psychologist Daniel Kahneman, there are 2 factors that characterize good decisions:

• well-calibrated confidence - do I understand this investment as well as I think I do?

• correctly-anticipated regret - how will I react if my analysis turns out to be wrong?

Graham says, that we should look at investing like a business. Like we own and run the business we invested in. With that in mind, we should adhere to certain business principles.

1. Know what you are doing - know your business.
   For investor this means that he must not try to make “business profit”. What this means is, that he should not anticipate returns bigger than average returns and dividend payouts. I would translate this principle in “manage your expectations.”

2. Do no let anyone else run your business, unless you can supervise them with adequate care or you have unusually strong reason for trusting them with your money.
   This does not mean that you should not ask for advice from informed individuals, however, you need to understand what you are doing and essentially make the end decision.

3. Do not enter a business unless a reliable calculation shows that it has a fair chance to yield a reasonable profit.
   Keep away from ventures in which you have little to gain and a lot to lose.

4. Have the courage of your knowledge and experience.
   If you have formed a conclusion from the facts and if you know your judgment is sound, act on it - even though other may hesitate or differ.

The probability of making at least one mistake at some point in your investing lifetime is 100% and those odds are entirely out of your control. However, you do have control over the consequences of being wrong.

By permanently diversifying and refusing to throw money at Mr Market’s latest trends, you can ensure that the consequences of your mistakes will never be catastrophic. No matter what Mr Market throws at you, you will always be able to say “This too shall pass”.