Naive Investor Chapter 4: Addendum

Ed: I will slow down with these chapters, as afterall 'The Intelligent Investor' has 20 chapters and is the culmination of Graham's life work. I'm up to 4 already and don't have as much to talk about.

I had a sudden insight that expresses Chapter 4's core message more succinclty. The Naive Investors default risk profile is this:

They desire maximum exposure to the upside with minimum exposure to the downside.

This is something Maquarie Bank's television ads capitalise (prey) on.

This win-win mindset is what makes the investor naive. Most people posess enough sense to know that on the whole the stockmarket will rise and fall daily, 'it will fluctuate'. You will notice the Naive investors risk profile above incorporates the word 'desire' an emotional, lustful feeling.

Desire is not so intellectual and this is why an intellectual framework and discipline is necessary.

To illustrate it think about the sharemarket. The default risk profile may tell you that Shares go 'upwards' in a jagged line. The market on average goes up one day (the price of some companies rise by an amount the is greater than the greater collective fall of the other companies) and on other days the market goes down (the value of some companies fall in price is greater than the collective rise in price of the other companies) The naive investor likes the rising parts of the jagged line, but they don't like the falling part.

This gives birth to the naive investors emotional strategy of 'direct shares'. It is based on a desire for the upside of the jagged market line without the unpleasantness of the downward market line.

How to do this? It seems simple enough, (enough to be naive) buy only the companies that will go up in price, and don't buy the companies that will go down. 'Pick Winners' in other words.

It is not enough that an index fund's net result over a year may be to increase your wealth, it becomes necessary (on a sheer emotional level) to 'beat the market' as the new 'minimum' performance level. Something increadibly hard to do over a year, and near impossible over the long term.

Why do I think this stems from naive emotional desires? Because it is incredibly rare for any managed fund to beat the market in a given year, and even rarer over 5 years, and almost unheard of over 10 years.

Yet people put their money into direct share 'growth' funds year after year that underperform a mindless 'index fund'.

The basic risk profile of 'I want exposure to the upside, and no exposure to downside' is crucially important. It has to be overcome before you start investing.

It's this emotional profile that I have in mind when I ask 'do you deserve to be rich?' if you aren't willing to take responsibility for your decisions (not just financial) then no, I don't feel you 'deserve' to be rich and I will put no effort into making you rich.

But accidents do happen.