This chapter will outline the viewpoints that will
be set forth in the remainder of the book. In particular we wish to develop at
the outset our concept of appropriate portfolio policy for the individual,
nonprofessional investor.
Investment
versus Speculation
What do we mean by “investor”?
Throughout this book the term will be used in contradistinction to
“speculator.” As far back as 1934, in our textbook Security Analysis,1 we
attempted a precise formulation of the difference between the two, as follows:
“An investment operation is one which, upon thorough analysis promises safety
of principal and an adequate return. Operations not meeting these requirements
are speculative.”
While we have clung
tenaciously to this definition over the ensuing 38 years, it is worthwhile
noting the radical changes that have occurred in the use of the term “investor”
during this period. After the great market decline of 1929–1932 all common
stocks were widely regarded as speculative by nature. (Aleading authority
stated flatly that only bonds could be bought for investment. 2) Thus we had
then to defend our definition against the charge that it gave too wide scope to
the concept of investment.
Now our concern is of
the opposite sort. We must prevent our readers from accepting the common jargon
which applies the term “investor” to anybody and everybody in the stock market.
In our last edition we cited the following headline of a front-page article of
our leading financial journal in June 1962:
SMALL
INVESTORS BEARISH, THEYARE SELLING ODD-LOTS SHORT
In October 1970 the same
journal had an editorial critical of what it called “reckless investors,” who
this time were rushing in on the buying side.
These quotations well
illustrate the confusion that has been dominant for many years in the use of
the words investment and speculation. Think of our suggested definition of
investment given above, and compare it with the sale of a few shares of stock
by an inexperienced member of the public, who does not even own what he is
selling, and has some largely emotional conviction that he will be able to buy
them back at a much lower price. (It is not irrelevant to point out that when
the 1962 article appeared the market had already experienced a decline of major
size, and was now getting ready for an even greater upswing. It was about as
poor a time as possible for selling short.) In a more general sense, the
later-used phrase “reckless investors” could be regarded as a laughable
contradiction in terms—something like “spendthrift misers” - were this misuse
of language not so mischievous.
The newspaper employed
the word “investor” in these instances because, in the easy language of Wall
Street, everyone who buys or sells a security has become an investor,
regardless of what he buys, or for what purpose, or at what price, or whether
for cash or on margin. Compare this with the attitude of the public toward
common stocks in 1948, when over 90% of those queried expressed themselves as
opposed to the purchase of common stocks.3 About half gave as their reason “not
safe, a gamble,” and about half, the reason “not familiar with.”* It is indeed
ironical (though not surprising) that common-stock purchases of all kinds were
quite generally regarded as highly speculative or risky at a time when they
were selling on a most attractive basis, and due soon to begin their greatest
advance in history; conversely the very fact they had advanced to what were
undoubtedly dangerous levels as judged by past experiencelater transformed them
into “investments,” and the entire stock-buying public into “investors.”
The distinction between
investment and speculation in common stocks has always been a useful one and
its disappearance is a cause for concern. We have often said that Wall Street
as an institution would be well advised to reinstate this distinction and to emphasize
it in all its dealings with the public. Otherwise the stock exchanges may some
day be blamed for heavy speculative losses, which those who suffered them had
not been properly warned against. Ironically, once more, much of the recent
financial embarrassment of some stock-exchange firms seems to have come from
the inclusion of speculative common stocks in their own capital funds. We trust
that the reader of this book will gain a reasonably clear idea of the risks
that are inherent in common-stock commitments—risks which are inseparable from
the opportunities of profit that they offer, and both of which must be allowed
for in the investor’s calculations.
What we have just said
indicates that there may no longer be such a thing as a simon-pure investment
policy comprising representative common stocks—in the sense that one can always
wait to buy them at a price that involves no risk of a market or “quotational”
loss large enough to be disquieting. In most periods the investor must
recognize the existence of a speculative factor in his common-stock holdings.
It is his task to keep this component within minor limits, and to be prepared
financially and psychologically for adverse results that may be of short or
long duration.
Two paragraphs should be
added about stock speculation per se, as distinguished from the speculative
component now inherent in most representative common stocks. Outright
speculation is neither illegal, immoral, nor (for most people) fattening to the
pocketbook. More than that, some speculation is necessary and unavoidable, for
in many common-stock situations there are substantial possibilities of both
profit and loss, and the risks therein must be assumed by someone.* There is
intelligent speculation as there is intelligent investing. But there are many
ways in which speculation may be unintelligent. Of these the foremost are: (1)
speculating when you think you are investing; (2) speculating seriously instead
of as a pastime, when you lack proper knowledge and skill for it; and (3)
risking more money in speculation than you can afford to lose.
In our conservative view
every nonprofessional who operates on margin† should recognize that he is ipso
facto speculating, and it is his broker’s duty so to advise him. And everyone
who buys a so-called “hot” common-stock issue, or makes a purchase in any way
similar thereto, is either speculating or gambling. Speculation is always
fascinating, and it can be a lot of fun while you are ahead of the game. If you
want to try your luck at it, put aside a portion— the smaller the better—of
your capital in a separate fund for this purpose. Never add more money to this
account just because the market has gone up and profits are rolling in. (That’s
the time to think of taking money out of your speculative fund.) Never mingle
your speculative and investment operations in the same account, nor in any part
of your thinking.
[The
Intelligent Investor - Benjamin Graham # Page 18 – 22]
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