By Michael D. Bird, CFP®, MBA
You may think that when you are making an investment you are “betting.” But as someone who’s been advising clients for over 21 years, investing is not gambling. However, you may have been led to think that from very credible sources. Look through any edition of The Wall Street Journal and you will see words like “bet” used in articles describing many investment strategies. In general, the financial news media has led you to believe that what you are doing with any investment is that you are hoping you will end up with more money than when you started. But “hoping” is not investing. So really, what is investing?
If you define an investment as the “expectation” of a return, that’s different from hoping for a return. Benjamin Graham, recognized by many as the father of value investing, wrote a seminal book entitled The Intelligent Investor. He became Warren Buffett’s professor. Warren Buffett has been one of the best investors in the history of stock markets and believes that Graham’s book is the best book on investing ever written. Here’s how Graham defined investing. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.” So, how can investing promise the safety of principal and have an adequate return?
Investments need to be analyzed. The purpose of Graham’s book was to show the reader how to analyze many investments, not just stocks. He spent considerable space in the book on stocks but also has chapters on bonds and mutual funds. We live in a world of enormous amounts of information and anyone can discover all kinds of facts about a company, its industry, and how that company compares to others in their industry, in their country, even the world. Some of the information is free, and some is not free. You have an ocean of information available and it’s relatively easy to get. The question becomes what information is useful for you. Graham’s instruction is to do the analysis yourself and make the decisions yourself.
Is the return of principal really promised? Let’s consider a potential investment. Consider a company that has paid a shareholder dividend every year for the past 24 years. After looking at the current year activity, etc. you raise a question. If everything looks the same, what are the chances that a dividend will be paid this year? Probably good. But is it guaranteed? The answer is no, it is not guaranteed. However, you have a pretty good chance that it will, barring anything unusual happening. This is some of what Graham was referring to. He was also considering some important financial measures that would show whether it was appropriately priced in the market. Believe it or not, bargains do occur in the market. Maybe not as readily as before the age of computers and computer trading. But good companies can be purchased at really good prices due to market factors. Graham was a gifted value hunter and very good at identifying those companies and then purchasing them.
What would an “adequate return” be? Now that’s something each of us must answer on our own.
Each of us has different goals. For some, just having a higher rate of return than a CD rate is enough. For others you may want to consider a return that grows your retirement savings to the point of a comfortable retirement (whatever that means). For others, they must have a higher return than the stock market as a whole. Everyone is different. Each has to decide the importance of their investment rate of return. But with a greater rate of return, usually, there is a greater risk. Why don’t savings accounts pay a higher rate? There is no risk. And the Federal Reserve has kept interest rates low for quite some time. So, if you are looking for a rate of return that’s high, the risk is usually that the market could deliver a low or negative rate of return. The question is whether your analysis showed that the stock, or the company represented by that stock, will eventually be recognized for its value. Sometimes, getting the adequate rate of return means you need to wait for the market to recognize the company’s value. So, getting the return means having patience.