The 3 Most Timelss Investment Principles

By Daniel Myers, CFA
http://www.taxopedia.com/articles/basics/07/grahamprinciples.asp

Warren Buffett is widely considered to be one of the greatest investors of all time, but if you were to ask him who 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 to be the father of security analysis and value investing.

Principle No.1:
Always Invest with a Margin of SafetyMargin 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. In simple terms, Graham's goal was to buy assets worth $1 for $0.50. He did this very, very well. To Graham, these business assets may have been valuable because of their stable earning power or simply because of their liquid cash value.

Principle No.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.

Here are two strategies that Graham suggested to help mitigate the negative effects of market volatility:

Dollar-Cost Averaging
Dollar-cost averaging is achieved by buying equal dollar amounts of investments at regular intervals. It takes advantage of dips in the price and means that an investor doesn't have to be concerned about buying his or her entire position at the top of the market. Dollar-cost averaging is ideal for passive investors and alleviates them of the responsibility of choosing when and at what price to buy their positions.

Investing in Stocks and Bonds Graham recommended distributing one's portfolio evenly between stocks and bonds as a way to preserve capital in market downturns while still achieving growth of capital through bond income. Remember, Graham's philosophy was, first and foremost, to preserve capital, and then to try to make it grow. He suggested having 25-75% of your investments in bonds, and varying this based on market conditions.

Principle No.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. PassiveGraham referred to active and passive investors as "enterprising investor" and "defensive investors".

You only have two real choices: The first 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, and 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.

If you have neither the time nor the inclination to do quality research on your investments, then investing in an index is a good alternative. Graham said that the defensive investor could get an average return by simply buying the 30 stocks of the Dow Jones Industrial Average in equal amounts.

by Daniel Myers, CFA (Email Biography)