The Intelligent Investor

Zweig calls Graham’s warnings for 1973 and 1974 “prophetic,” saying that Graham successfully saw the signs of the coming bear market and that his warnings could have also been applied to the market of the late 1990s and early 2000s.

Zweig emphasizes that the stock market is unpredictable. He warns against overconfidence when predicting stock prices, as past performance does not necessarily indicate future success: “The heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past” (80). Zweig criticizes the hubris of forecasters who downplay risk and overestimate their ability to predict the market. He cites strategists like Robert Froelich and Jeffrey M. Applegate as examples of experts who made optimistic and inaccurate predictions about the stock market in the year 2000, just before the dot-com bubble burst.

Graham discusses the portfolio he recommends for the defensive investor—the type of investor who does not wish to actively manage their investments and who therefore requires a more conservative and low-risk approach. The chapter highlights the importance of diversification and the allocation of assets between stocks and bonds. Graham suggests that the defensive investor should aim for a balanced portfolio consisting of 50% stocks and 50% bonds. He argues that this allocation provides a reasonable level of safety and potential for growth while mitigating the risks associated with a concentrated portfolio.

He advises that the 50-50 split between stocks and bonds should not become skewed to more than a 25-75 or 75-25 split. Graham acknowledges that while there are no definitive guidelines for determining the exact proportion of stocks and bonds in a portfolio, a balanced 50% allocation offers a reasonable compromise between risk and return. Graham goes on to discuss the conditions under which an intelligent investor may deviate from the 50% equity and 50% bond allocation. He suggests that this may be determined by the investor’s “own temperament and attitude” as well as the market conditions (91).

Graham discusses two questions that arise when deciding which bonds to include in the defensive investor’s portfolio: Should one buy taxable or tax-free bonds? And should they be short or long term? He says that the question of taxable or tax-free bonds depends on the investor’s tax bracket and their life circumstances. The question of bond maturity depends on the duration in which an investor intends to hold their investments and their willingness to bear financial risk.

Graham reviews the types of bonds available to the defensive investor, including government bonds, municipal bonds, and corporate bonds. He explains that government bonds are considered to be the most secure form of fixed-income security due to their reliance on the government’s capacity to levy taxes and produce currency. Municipal bonds, which are issued by governmental entities at both the state and local levels provide tax-exempt interest income for investors under specific conditions. Conversely, corporate bonds are issued by companies and entail relatively greater risks when compared to government and municipal bonds.

He then discusses preferred stocks, which are a hybrid form of investment that combines features of both bonds and common stocks. Graham claims that their investment form is “an inherently bad one” since preferred stocks have a lower priority in terms of dividend payments and liquidation rights compared to bonds (98). For these reasons, he does not recommend investing in preferred stocks for the defensive investor.

Zweig notes that “the most striking thing” about Graham’s advice regarding the allocation of stocks and bonds is that he does not mention age (102). While some people advise that the equity allocation in an individual’s portfolio should be determined by subtracting their age from 100, Graham’s approach is more comprehensive and considers individual characteristics beyond age. Overall, it is more focused on temperament and the investor’s tolerance for risk.

Zweig emphasizes the importance of understanding one’s current life circumstances and future goals when deciding how to allocate one’s portfolio between stocks and bonds. He offers a series of questions that investors can consider to assess their risk tolerance and evaluate the fundamental aspects of their financial situation. These help individuals determine when they should assume certain risks, whether they can anticipate potential changes in their circumstances, and how they can understand the impact of these changes on their cash requirements. According to Zweig, one should consider factors such as marital status, inheritance, children, employment, and salary, as well as factors that may hurt financial stability such as potential job loss.

Zweig advises the defensive investor to choose a ratio between stocks and bonds according to the above factors, and he recommends that they rebalance this ratio only twice per year, to avoid making frequent changes based on short-term market fluctuations.

Graham explores the concept of the defensive investor and their approach to investing in common stocks. While stocks are generally riskier than bonds, Graham makes the argument that common stocks can still be a viable option for defensive investors if they follow certain principles and criteria.

He lays out four rules for defensive investors to consider. One: Defensive investors should have adequate diversification thereby reducing the risk associated with individual stock holdings. Two: Defensive investors should focus on larger, well-established companies that have a history of stable earnings and dividends. Three: Defensive investors should prioritize companies that pay dividends consistently, as this can provide a reliable source of income. Four: Defensive investors should carefully evaluate the price at which they are willing to purchase stocks, ensuring that they do not overpay.

Graham discusses “growth stocks,” stocks that have grown at above-average rates in the past and are expected to continue at a similarly rapid pace. He advises that growth stocks may not be suitable for defensive investors as they tend to be more speculative and volatile.

He goes on to describe the investment technique known as dollar-cost averaging, in which an individual commits to investing the same fixed amount of money at regular intervals (for instance, once a month), regardless of the current state of the stock market. This strategy allows the investor to ultimately even out the average cost per share over time. Graham regards this approach as a prudent and disciplined method for defensive investors to navigate the ups and downs of the stock market.

Graham concludes the chapter by exploring the definition of “risk.” He says a stock’s “risk” is often used to mean the possibility of a decline in value. However, he believes that the true risk lies in the potential for permanent loss of capital. He claims that an investor acts riskily only if they buy a security without thoroughly evaluating its intrinsic value and margin of safety thus leaving themselves vulnerable to overpaying.

Zweig debunks a popular piece of advice about investing to “buy what you know” (125). He argues that this approach can lead to overconfidence and a lack of diversification, both of which can be detrimental to investment success. He argues that it is easier than ever to diversify one’s portfolio and place it on autopilot by investing in low-cost index funds. He recommends this approach to the defensive “intelligent investor” as it removes the need for constant monitoring and analysis of individual stocks.