Sunday, December 02, 2007

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)

5 comments:

  1. Value investing is high risk or percieved to be high. Time is the key. Recently, Warren Buffet bought Bear Stein.He though it was a good buy after doing the sum. Bear was badly mauled by the sub prime. Whether Warren is right or wrong only time will tell.
    What is the intrinsic value of Bear stein? It is anyone's guess. It is 'agak agak' only .

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  2. Active investing sometimes leads you to stray into market timing inevitably and i believe this is the reason Benjamin Graham calls them enterprising because active investors HOPE to out perform the benchmarks. A good try.Today there are still many of them. Good luck to them.
    Research has revealed that only 17% actively managed funds outperformed and if the returns are adjusted for costs the number is smaller. So why try? ETFs look better alternatives.

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  3. Low quality advice by this Daniel angmoh. Everyone knows about buy low sell high. my grandmother also knows. is there something else that this Daneil guy can show us, like how to spot stocks that will move up next week?

    all this theory is just theory. anybody also know how to sing a song like that. if he can show the way to pinpoint exactly how to identify the right stocks, then good and not waste people's time.

    i think stick to ETF sure win.

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  4. While Principle No. 1 sounds logical, it is difficult to follow. How could ordinary investors know the intrinsic value of a stock?

    Graham (together with Dodd) developed the Discounted Cash Flow (DCF) model that is widely used for valuation. As with any model, DCF works only if the inputs (mainly from financial statements) are correct; otherwise, it will be GIGO.

    However, financial statements now are very convoluted and their face values are not credible; the management could always exploit accounting loopholes to overstate revenues or understate expenses.

    There are techniques to deconvolute accounting figures to try to understand the real and sustainable cash flow of the company. The financial analyst plays a cat-and-mouse game with the management and it is difficult to consistently prevail.

    Consequently, value-investing (using DCF to find the intrinsic values of stocks) is a difficult game to win. Only a few and the previlege could win big, like Buffett.

    Indexing is more suitable for ordinary investors.

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  5. It seems the resounding vote goes to Index or ETFs. For the ordinary folks don't ever listen to the your insurance agents when it comes to investment. I despise them. They are the cause of your loss of CPF money. Believe me you, they always try to sound clever. They tip you when to buy and to sell, right? They seem to know when it is right time and wrong time , these smart aleks." Hai see lan" all of them. Inevitably you buy high and sell low instead.
    The safest is to invest in index funds, the bench mark.

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