Ben Graham spoke to a group of bankers in 1951. It was unique in that he addressed their increasing role as investment advisors. He offered some timeless advice for advisors and investors alike.
He began with a brief history of portfolio construction — stocks and bonds. For years, bonds were the smart safe investment of choice for bankers and individuals, while stocks were speculative. That all changed in the early 1920s.
People learned stocks held a few advantages over bonds — better inflation protection, capital appreciation, and, in general, a better overall return. And eventually, stocks gained a more prominent foothold in portfolios.
But it wasn’t all good news. Stocks had a few downsides too. Three, in particular, stood out to Graham.
First, investing in stocks often leads to speculating in stocks, which ends in losses. Second, there’s a tendency for overpriced, low-quality stocks to be sold to investors through IPOs or scammy advice. Third, the timeless nature of investors is to buy high and sell low, creating a cycle of bad results.
Then Graham summed it up with this bit of wisdom:
I would like you to pay special note to this fact: The disadvantages which I have listed for common stock investment are all psychological in their origi, while the advantages which I have listed are all economic and objective in their nature. In other words, if investors weren’t people, common stocks investment would be a 100% sound proposition. Unfortunately, investors are people, and they have a great tendency to do the wrong thing when they enter the field of common stocks…
My conclusion on the pros and cons of common stocks has to be expressed in this form:
In a sense, the argument for common stock investment is too good. It tends to make for over-confidence in common stocks at the wrong time. That is to say, it gives too great theoretical support to what is almost certain to end up as excesses of speculation…
You bankers, I urge, should accept the theory of common stocks as a medium of investment; but accept it warily, not as a Gospel, but as a business propostion subject to continuous business test.
Please do not forget that as the common stock level advances, the advantages of common stocks appear to be more attractive and the basic need for owning them becomes more persuasive in everybody’s reasoning. Yet, in fact, common stocks undoubtedly become riskier as the price advances, and thus the risk increases as the widespread acceptance of common stock develops.
Graham realized early on that the biggest risk is ourselves. If we could just get out of our own way, our portfolio returns would improve. He followed that up with not trying to exceed our own abilities.
And that was his advice to the bankers. The best way the banker could help their clients wasn’t to forecast the market or pick “winners.” Graham was skeptical they could do it.
Instead, they should follow the investment approach that fit most clients — likely the defensive approach. The main goal of a defensive investor is to avoid mistakes and losses.
So the goal of the banker, as an advisor, was to manage behavior. A diversified portfolio, combined with eliminating mistakes, was the best way for the client to earn a satisfactory return.
The Banker as an Investment Counselor