Lesson 1: There are 3 principles to intelligent investing.
Often also called value investing, intelligent investing according to Benjamin Graham rests on 3 principles.
- An intelligent investor always analyzes the long-term evolution and management principles of a company before investing.
- An intelligent investor always protects him- or herself from losses by diversifying investments.
- An intelligent investor never looks for crazy profits, but focuses on safe and steady returns.
A famous quote by Warren Buffet is about his 2 rules for investing.
Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1.
That’s exactly what intelligent investing is. Nobody can predict the next Facebook, but everyone can protect themselves against losses.
By doing a thorough analysis, intelligent investors find stocks with a gap between their current price and the intrinsic value the company holds and will eventually unlock. This is based on the evidence collected from looking at the company’s history and their management values.
The intelligent investor invests in a few of those companies, in order to not lose everything when things go wrong and then sits back, being perfectly happy with collecting 10%, 12% or even 15% a year in returns.
Lesson 2: Never trust Mr. Market.
Graham’s most famous analogy is the one of Mr. Market, where he pictures the entire stock market as a single person.
If you imagine Mr. Market showing up on your doorstep every day, quoting you different prices for various stocks, what would you do?
According to Benjamin Graham, you’d be best off ignoring him altogether, day in and day out. Sometimes the prices he’d tell you would seem suspiciously cheap, sometimes astronomically high.
That’s because Mr. Market is not very clever, totally unpredictable and suffers from serious mood swings.
For example about a month before a new iPhone is released, stocks rally while people cue in line in front of the Apple store. But when the new phone is not exactly as expected, stocks can plummet the very next day.
As humans we’re so good at recognizing patterns, that we’re trying to find them even where none exist. That’s why we naturally a stock price that’s been going up for 10 days must go up further – which is of course not true.
If you want to be an intelligent investor, rely on your own research and ignore the market altogether.
Lesson 3: Always stick to a strict formula and you’ll do fine.
Lastly, to further remove you from the emotional stress of investing with the market, you should always stick to a strict formula when investing.
Graham calls it formula investing, but it’s more widely known as dollar cost averaging.
What it means is that you simply set a fixed budget you’re going to invest every month or quarter, and then invest that into the stocks you’ve previously picked – no matter the price.
For example, I invest 10% of my income every month. That money goes to my investment account on autopilot and then I invest it in the stocks I already own.
This is somewhat emotionally demanding, because it requires you to invest the same amount again and again – no more when stocks are cheaper, no less when stocks are expensive.
But once you get over it, it’s a great way to protect yourself against losses, which could happen if you invest a big sum right before a crash.