The Naive Investor - Chapter 1

Introduction:

I get angry and nasty. I think it is at the world, but I believe that I am actually angry at my own insignificance. So I decided to just calm down and stop being angry, and quietly work away at... things. This happened on my holiday.
Also on my holiday I read 'The Intelligent Investor' by Benjamin Graham, an important book I suspect. The funny thing about 'investing' is that it is just such a subject to inspire anger, as it is particularly prone to illustrating some of the pitfalls of human nature.

Reading publications like 'The Financial Review' and 'Crikey' and 'BRW' and their global equivalents promotes a temptation to be nasty and synical about peoples foolish 'investment' behaviour. It doesn't really help anyone.

So I intend to write a reflection on 'The Intelligent Investor' that succeeds in being helpful, if only to me rather than a self indulgent snipe at the stupidity of 'investors'.

So without further introduction -

Chapter 1: Bastardized Terms.

You may notice that I wrapped many instances of 'invest' in the sarcastic quotation marks in the introduction. This is because Invest/Investment/Investor are bastardized terms. That is to say, their meaning in common usage has departed from their original intent.

Benjamin Graham (author of the Intelligent Investor) defined an investment as:

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

(my emphasis)

I have been given the impression by many that something is an 'investment' if it is an assett, regardless of the price paid for it, how it will generate a return or the purchasers understanding of the assett class and/or their specific purchase.

The most common place to hear 'investment' misused is 'investment property' yet it never seems to be affixed to something like 'share portfolio' or even 'shares' people don't have 'investment shares' and 'investment share portfolios'.

But far from deeming 'investment' as superfluous in the case of property, it is innapropriate often. Because often the analysis is not thorough, nor are there 'promises of safety of principle and an adequate return.' There cannot be, because their is no analysis.

Benjamin's definition introduces another term 'speculative' or 'speculation' (and perhaps the least known 'speculator') The dividing line between 'investment' and 'speculation' is knowledge.

Speculation is basing decisions (in this context to purchase, hold or sell) on assumptions rather than thorough analysis. Even after thorough analysis of any share, property, bond etc purchase anyone is going to speculate to some extent. Thus in practice you are speculating when you simply don't bother to understand information made available to you.

It will most commonly manifest as 'Property Prices have been going up and I expect them to continue.' rather than checking ABS sensus data to get a sense of the supply/demand balance, understanding the effect of interest rates, government subsidies or even the current rental income.

Thus many of us naively call ourselves 'investors' where we mean 'speculators'. Why is it important to know that 'investment' is a bastardized term? To create an intellectual and emotional framework for making investment decisions.

Benjamin Graham points out that 'much bad advice is given freely' and I was sorely tempted to call my psuedo-book 'Your Stupid Parents' for my generation they greatest source of investment risk by virtue of their advice.

Thus if you want to be an 'investor' endeavor to make the following true of yourself:

1) That you understand to increase your wealth, the benchmark is inflation and only inflation. So long as you outperform inflation your wealth has lost no purchasing power.

2) You understand you don't need to 'beat the market' or be in the top performing managed fund, not losing money is a real achievement for an investor.

If you know the above to be true you will be innoculated to much speculative fever (though not strictly immune from the temptation).

The single greatest piece of investor knowledge you can possess is a good and true definition of 'investment' itself. Speculation is for most people only diagnosed in hind-sight by news and media and even then many speculators don't realise the news reports are talking about them.

Speculation has many negative connotations (like the word 'moron') and people like to think of themselves as 'investors'. Investor 'good', speculator 'bad' it is not necessarily any more complicated than that.

By knowing that "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return." you know when you are doing 'good' as opposed to 'bad' and can begin to moderate your own investment behaviour.

Thus when a gamble on a powderkeg housing market blows up in your wallett you can actually blame yourself, possessing the knowledge that you pushed your money into something you don't understand.