Things to Look out For
Benjamin Graham in his book “The Intelligent Investor” defines investment activity in the following words:
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
These words of wisdom on investing by Mr. Graham are unique and have significant Communication in-bytes as follows:
Investment Operation – Investing requires adequate efforts in terms of research and understanding the investment options available, determining their suitability for the needs of the investors and their appropriate value. Investing is not a one-time activity, but one that requires regular tracking, monitoring and suitable changes to the investment decisions based on new set of information and understanding. The activities associated with investments must be undertaken in a disciplined and systematic way. Mr. Warren Buffett also stated “Investing is most intelligent when it is business like.”
Thorough Analysis – Buying shares of a company is equivalent to taking part ownership in a business. Indeed, buying a business (fully or partly) is alternative to starting a business and would demand same kind of research and analysis as would be required when considering to start a business on various dimensions of the business – product, customers, inputs, outputs, bargaining power of business vis-a-vis other external parties such as suppliers, customers and others, competition, regulatory environment, potential opportunities, threats.
Safety of Investment – Graham says that first objective in investing has to be to protect the investment value for which it is important to identify opportunities that provide a margin of safety (MOS). In investments, this means investing in opportunities available at prices lower than their perceived value. Backed by strong research and monitoring, an investment portfolio should be able to protect the investor’s investment value over a suitable investment horizon, despite short-term fluctuations in the market.
Adequate return – While meaning of adequate is not defined by Graham, it would probably mean risk adjusted return in comparison to other competing avenues for invested capital. It is important to understand the risk and return features of an investment before committing to it. Investors that follow the above tenets are said to be engaged in investing. Following are the learning(s) for common investors from this definition of investing.
Difference between investing and speculating – There is an unambiguous demarcation between investing and trading. Investing money without going through the rigor of understanding and analyzing the investment options, their risk and return features and appropriate value would be like taking a bet or speculating rather than investing. Such activity has a greater chance of losing rather than making money for the investors. Speculation is typically short-term calls made with leveraged funds, unlike investing money which is a long-term disciplined activity for creating wealth.
Align Investment to Needs – A good investment option available at a reasonable price may still not be suitable for an investor if it does not meet his investment needs. Investment needs can be primarily defined in terms of the nature of return required, the risk that the investor is willing to take and the investment horizon. For example, investing in a well-researched growth stock may not be suitable for a retired investor looking for regular income from his investments.
Investing demands hard work – The activities involved in investing require a large commitment of time and efforts, along with the skills and understanding to collect relevant data, analyze the investment options, execute the decisions and monitor the investments made. Most investors may find that they fall short on these requirements. Making investment decisions without the necessary skills would mean that the investor’s money is not being deployed in the best way possible.
Become a skilled investor or hire someone to manage money – The investors can either develop the skills required to make and manage their investments or find someone with the qualification who they can trust to do so. Investors should never forget to do due diligence (research) on the money manager. They should focus on aspects such as qualification, experience, performance track record, systems and support facilities, integrity, philosophy of investing and other relevant factors of the money managers.