The first investment book I ever read was Benjamin Graham’s The Intelligent Investor. This is one of a handful of books you hear mentioned over and over again when you ask investors to name the best investing books of all-time. The edition I read was annotated by Jason Zweig, which was very helpful because he was able to provide context around many of the subjects that were included in the original version which was written in the 1950s.
I recently came across an old piece that Zweig wrote for the CFA Institute that outlined some of the lessons learned from that experience. Zweig touches on Graham’s five kinds of brilliance:
- Intellectual brilliance
- Financial brilliance
- Prophetic brilliance
- Psychological brilliance
- Explanatory brilliance
One of the more fascinating anecdotes Zweig talks about that I had never heard before is that before graduating from Columbia University Graham had already received offers to stay on as a professor in three different subject matters — english, philosophy and mathematics. Graham was a true Renaissance man.
And then there’s the fact that he more or less came up with the idea for the CFA program, which is now the gold standard in portfolio and investment management as far as higher education goes.
But the thing that has always impressed me when reading Graham’s work is how far ahead of his time he was in talking about investor behavior and human psychology in terms of the role they play in shaping how markets and investors generally work:
Graham’s insights into human behavior are remarkable. He made quite clear that the central difficulty of investing, both for retail and for professional investors, is that we are all our own worst enemy. We buy high; we sell low. We do the worst possible thing at the worst possible time because we are most certain that we are right just when we are most likely to be wrong. And Graham understood that we act this way because of the way we are designed.
Zweig then goes on to talk about how Graham’s insights are relevant for financial professionals in dealing with their clients:
Graham also understood an important and subtle point for investment professionals who are assisting individual investors—the importance of focusing not on what people ought to do to get optimal results but, rather, on what they can do. The best investing advice is not theoretically ideal but psychologically practical.
Throughout the book, he made similar points that are psychologically insightful. For example, when he was talking about his market-timing formula, he admitted that the formula was not all that good. He admitted how difficult it is for an investor to know with any degree of certainty that stocks are indeed overpriced. But he also knew that an investor would never go broke using the formula, and as he put it: “The chief advantage, perhaps, is that such a formula will give [the investor] something to do” (2003 edition, p. 197). Graham understood that investors need something to do. Psychologists refer to it as the “illusion of control.” It is why we blow on the dice when we are playing craps. It is why we push the elevator button nine times after we have pushed it the first time; we think we can make the elevator arrive more quickly if we keep pushing that button.
There are three ways to look at an investor’s risk profile:
- How much risk they are able to take (current financial situation)
- How much risk they need to take (require rate of return to reach goals)
- How much risk they are willing to take (appetite for risk)
It’s that last one — an investor’s appetite for risk — that Graham was touching on here. It’s not enough as an advisor or portfolio manager to say, “Think long-term and stay the course.” Words alone aren’t going to keep someone invested. There have to be behavioral checks and balances in place to ensure that clients can and will stick with their portfolios and plans. There are a number of ways you can do this:
- A risk management strategy
- A rules-based approach
- Intelligent communication
- Portfolio design
- Setting the right expectations
This is the whole point of Graham’s concept of margin of safety — you have to leave room for error, both in terms of your investing decisions and your behavioral actions.
Managing other people’s money is about more than merely investment or portfolio management — it’s also about managing their emotions. Graham understood this better than anyone. It’s a timeless lesson.
Benjamin Graham: Father of the Efficient Market Hypothesis?
Now here’s what I’ve been reading this week:
- Why Warren Buffett’s hedge fund bet matters and doesn’t (Vanguard)
- How the NBA destroyed league parity (EconomPic)
- Are markets efficient? Fama vs. Thaler (Chicago Booth)
- How dare you make us eat our own cooking (Reformed Broker)
- Losing my religion (Samuel Lee)
- What is risk? (The Personal Finance Engineer)
- Your most valuable financial asset (White Coat Investor)
- Just don’t do it (Tim Hanson)
- Creating an alternative investment strategy with value & momentum (Alpha Architect)
- The 9 rules of research according to Ned Davis (Andrew Thrasher)