The Intelligent Investor (Rev Ed)
Benjamin Graham and Jason Zweig

“It is no difficult trick to bring a great deal of energy, study, and native ability into Wall Street and to end up with losses instead of profits.”

“Allocating at least 10% of your retirement assets to TIPS is intelligent.”

“The worse the future looks, the better it usually turns out to be.”

“The primary cause of failure is that investors pay too much attention to what the stock market is doing currently.”

“The key to rebalancing is having a predictable schedule”

“For most investors, intermediate bonds are the simplest choice, since they enable you to get out of the game of guessing what interest rates will do.”

“For most investors, bond funds beat individual bonds hands down.”

“If you had invested $1 in U.S. stocks in 1900 and spent all your dividends, your portfolio would have grown to $198 by 2000. But if you had reinvested all your dividends, your portfolio would have been worth $16,797.” (Stock indexes do not include dividends.)

“It is essential that (the intelligent investor) entrust himself only to firms of the highest reputation.”

If you find yourself trading more than twice a year–or spending more than an hour or two per month on your investments–then something has gone badly wrong.”

“If you started investing $100/month in September 1929, your money would have grown to $15,571 by August 1939. That’s the power of disciplined buying–even in the worst bear market of all time.”

“The knowledge of how little you can know about the future, coupled with the acceptance of your ignorance, is an investor’s most powerful weapon.”

“Alan Greenspan said on January 7, 1973: “It’s very rare that you can be as unqualifiedly bullish as you can now.” (1973 and 1974 turned out to be the worst years for the stock market since the Great Depression.)”

“A great company is not a great investment if you pay too much for the stock.”

The Intelligent Portfolio
Christopher Jones

“Sadly, our educational system has been woefully behind the curve in preparing people for the heavy new financial responsibilities of a self-directed investment world.”

“Be careful of how your advisor gets paid. Conflicts of interest can yield advice that is not in your best interest.”

“There are many ways to measure risk other than looking at just the volatility of returns.”

“A study of investor behavior by the research firm DALBAR found that market timers in stock mutual funds lost -3.29% per year on average relative to investors who pursued a consistent strategy.”

“Unlike a mutual fund, it is quite possible for a single stock to lose all its value by going bankrupt.”

“Never make the critical mistake of being too concentrated in your employer’s stock.”

“Fund expenses are like termites. They can quietly eat away at the returns of your investment without you even realizing there is a problem.”

“From the analysis of 22,472 mutual funds–only about one quarter of mutual funds were able to demonstrate performance that exceeded what you could achieve with a low-cost index fund.”

“Evaluate diversification at the household level, not at the individual account level.”

“If you own a home already, you probably have enough real estate in your household portfolio.”

“Asset allocation explains more than 90% of the variation in returns for most mutual funds.”

“You are virtually guaranteed to outperform more than two-thirds of the actively managed funds with low-cost index funds.”

“It is very expensive to guarantee that you will have a certain amount of money in the future, but if you can tolerate some uncertainty, you can likely fund your future goal with significantly less savings.”

“The only way to be more confident of reaching a financial goal is to invest more conservatively and save more.”

“All other things held equal, it will cost a woman more to fund her retirement than a man of the same age due to her longer expected lifespan.”

“As an investor, you want to be cautious about investing in a fund just prior to it making a distribution to shareholders.”

The Individual Guide to the Top Mutual Funds
American Association of Individual Investors

“The most important factor when diversifying a portfolio is selecting investments whose returns are not highly correlated.”

“Bond mutual funds are attractive to investors because they provide diversification and liquidity, which is not as readily attainable in direct bond investments.”

“The higher the turnover, the greater the brokerage costs incurred by the fund.”

“The market risk measure used for common stocks is beta; for bond funds, average maturity is used.”

“Dollar-cost averaging works especially well with more volatile portfolios.”

“Top Performance lists are dangerous.”

“The classic response of funds that focus on small stocks is to migrate investments to mid-cap and large stocks when they start to achieve a large asset base.”

“Don’t forget that almost all fund performance data is reported without adjusting for front-end or back-end loads.”

“One reason beyond low expense ratios that make index funds are tough to beat is that they are always 100% invested in the market.”

To be continued …. here.

This restriction has come under question lately, a recent manifestation being a paper written by Poonam Puri, an Associate Professor of Law at Osgoode Hall Law School. There are two main complaints:

• pension funds are blocked from becoming active investors and pursuing the maximization of shareholder value
• Canadian pension funds are put at a competitive disadvantage vis-à-vis foreign pension funds (Canada is the only OECD country that imposes such a rule).

Professor Puri argues the rule should be abolished for the above two reasons plus the fact pension funds are increasingly finding ways to get around the rule anyways. He cites three instances by the Ontario Teachers’ Pension Fund to achieve technical compliance with the 30% rule:

• use of convertible debt (e.g. private placement of convertible debentures from Railpower Technologies Corp. in 2007)
• use of convertible non-voting shares (e.g. non-voting shares issued by Maple Leaf Foods Inc. in 2007)
• use of a shell company to own and vote shares as the pension fund directs (e.g. attempt to privatize BCE Inc.)

The professor makes a good case. But what about the original purpose of the rule — which was to prevent pension funds from owning major pieces of the Canadian economy? Pension funds represent the interests of specific social groups such as unionized teachers, auto workers, and civil servants: would companies and sectors controlled by their pension funds be run in a way beneficial to the companies themselves, minority shareholders, and indeed, the whole of society — or more in the interests of these organized groups and their retirees?

Many posters in the Canadian Business Online discussion forum and elsewhere have made references to Foster’s “original sin” of publishing a misleading investment guide. His book purports to show how investors can stop working at an early age — like he did — by building up a portfolio of dividend stocks. However, what the book neglected to mention, as the author later revealed in response to critics, was that he amassed his portfolio with aggressive, leveraged bets on a few stocks. So the real story apparently was as much about betting big on capital gains in hopes of earning investment returns better than Warren Buffett.

Most people seem to accept this explanation of how he managed to “retire” early. Personally, I am still wrestling with the uncertainty he actually did accumulate such a portfolio, after interviewing him a few years back and coming across a few anomalies (see Sept. 27, 2007 and Feb. 28, 2008 columns). But it’s neither here nor there whether or not he did. The main takeaway, in my opinion, is the unfortunate failure to stick with the plan laid out in his book. For example, Chapter 5 says: “Let’s pray for a market crash!” because then we can buy more dividend stocks on the cheap. And, as he wrote, when it comes to dividend stocks “… you NEVER sell them!”

“… investing is as much about character as it is about analytical capability. Character is about having strength in the face of adversity, of being able to hold onto what you believe in while others around you are losing their moorings,” it says in Toughing it out.

Analyzing trading data from the Australian stock market between 1990 and 2005, the paper finds that individual investors at discount brokers lose to institutional investors and individuals at non-discount (e.g. full-service) brokerages over nearly all trading periods. That is, their buys underperformed their sells, in contrast to institutionals and clients of full-service brokers.

One major reason for the underperformance was trading just after the exchange opened for business. Since institutionals and full-service clients have better access to research and other information sources, discount-broker clients trading just after the opening bell are operating with less information on overnight developments.

Another major reason is that discount-broker clients do not have the same facilities or time for monitoring their limit orders — so they may get “picked off.” They may, for example, put in an order to sell a stock at $30 when the price is $25, and if the price suddenly jumps to $40, investors more closely monitoring the market may pick off the investor with the limit order at $30 — and pocket the extra $10.

Who Win and Who Lose Among Individual Investors?
Kingsley Fong, David Gallagher and Adrian Lee
February, 2009

INK Research says:

“During the past 90 days, insiders at International Forest Products (IFP.A) have bought 616,900 shares in the public market. The biggest buyer has been board chair Lawrence Sauder who acquired 401,000 shares at prices ranging between $1.25 and $1.70 …. CEO Duncan Davies bought 100,000 shares at prices ranging between $1.77 and $1.92 and CFO John Horning bought 66,800 shares at prices ranging between $1.30 and $1.75. Other insiders who bought shares included officer Stephen Williams (30,500 shares), director John Sullivan (20,000 shares), officer Otto Schulte (7,000 shares) and chief operating officer Sandy Fulton (1,700 shares).”

The more senior and numerous the insiders, the more significant the insider-buying signal, research studies have shown. On this basis IFP.A is sending quite a bullish signal – which is rather amazing considering how dire housing and the economy now look.

On the other hand, the Canadian dollar has plunged from $1.05 (U.S.) to $0.77 (U.S.) in just over a year, making Canadian forest products much cheaper in the U.S. (and other foreign markets). In addition, a massive fiscal and monetary stimulus is being unleashed in the U.S. and around the world, which could produce another upturn in the business cycle at some point.

But could this insider buying be another head fake? In November, for example, an Investing Ideas blog post reported on insider buying at another Canadian forestry company, Canfor, and it is down more than 20% since then. Or will patience be ultimately rewarded?

“Among the factors causing strains,” writes the author, “will be the fallout from unraveling economies and heightened resource constraints, waning U.S. power and global competition for influence … boundaries will shift and alliances will unravel, much like they did when the Communist Party was no longer able to exert its authority over the Union of Soviet Socialist Republics….”

A sign of a good book is that it gives the reader new perspectives and stimulates their thinking – even if they happen to disagree in whole, or part, with the author. Panzner’s latest book easily passes this test.

For example, I was intrigued by the questioning of the notion that foreign diversification is good for portfolios. This popular view might not deliver as well as expected when the world economy is contracting and protectionist measures are multiplying. “The “risks of investing … abroad will be far greater than in the past,” writes Panzner. During de-globalization, “countries will be less concerned about protecting foreigners’ rights ….”

Living in Canada, I got a kick out of reading that one of the few bright spots in the panorama of gloom was Canada. The country “seems to offer great promise as an investment destination. With its relatively stable history and political structure … rich deposits of hydrocarbons and other commodities, access to water, and arable land for farming, the country would seem to have a lot going for it.”

Major themes in the book include:

• a surge in protectionist measures and consequent prolongation of the economic contraction — in unison with other “second-order effects,”

• an extended retrenchment in the free-spending American consumer and firms catering to them,

• ever more perilous government finances that lead to cutbacks to government programs, hikes in tax burdens, forced conversions of investments into government bonds, and a resort in the U.S. to the printing press that may trigger “a hyperinflationary spiral,”

• general loss of confidence in U.S. dollar and other fiat currencies and concomitant rise in preference for precious metals as store of value,

• stocks and bonds will be undesirable asset classes; embrace commodities and resources

• threat of economic blackmail and loss of influence posed by vast reserves of U.S. dollars held by China and other countries

• continued slide in real estate prices, until 2012 at the earliest,

• suburbs to become a wasteland due to water and energy limits,

• rise in civil, regional, and international conflict

When Giants Fall: An Economic Roadmap for the end of the American era by Michael Panzner, John Wiley & Sons, 2009

I agree with those who say investing is as much about character as it is about analytical capability. Character is about having strength in the face of adversity, of being able to hold onto what you believe in while others around you are losing their moorings. It’s about following your own counsel regardless of the crowd view. It’s about having perspectives such as the following:

1. Things are easier to endure if you maintain a healthy balance in lifestyle – proper diet, fresh air, exercise, and other diversions. In Ottawa, a good two-hour skate from one end and back on the canal (world’s longest skating surface) does wonders for clearing the mind. So does a trip away somewhere where the activities are guaranteed to occupy you, like a visit to a cross-country ski resort in the Laurentian Mountains north of Montreal. Needless to say, checking your account and the pulse of financial markets every hour is not part of the prescription.

2. Using mental imagery techniques may help – for example, envisioning what the stock market will look like three to five years from now. Chances are it will be more like the beginning or middle of the last bull phase, from 2002 to 2007. All this anguish will be a faint memory.

3. As mentioned in my column, Why investor’s get burned, realize we are in the phase of the bear market when all the doomsayers look like they were right and are getting major air time in the media. After awhile, they begin to sound plausible. The bottom in the market is four years away says one. Civil unrest in the streets says another. So like Ulysses, you have to “tie yourself to the mast” lest the Sirens’ song lure you into changing direction or jumping into the sea.

4. If the thought of having lost so much money wears on you or even keeps you awake at night, get proactive with making and executing plans for recouping some of the losses via application of your human capital. That is, you may be able to leverage your career training and experience more. Perhaps that might require spending less time on hobbies and more time in income earning pursuits.

5. Keep in mind the history of stocks markets. For example, the greatest rally in the market occurred in the midst of the Great Depression, when the Standard & Poor’s 500 Index rocketed over 100 per cent during the three months from July to September of 1932. The second greatest rally also occurred during the Great Depression, in the 1933, the year after the first greatest rally.

Take the Stay Invested calculator. It demonstrates the value of the buy-and-hold approach by showing the impact of missing some of the best-performing months over a 30-year period (from 1969-1999, using the TSE Total Return Index).

According to the calculator, missing just six of the best months cut returns nearly in half. A $10,000 investment yielded $233,294 at the end of 30 years under buy and hold versus $118,494 for the investor who missed the six best months.

There may be something to be said for buy and hold, but some people would say the Stay Invested calculator is more a marketing tool, a way to keep clients invested so advisors can continue to collect annual management fees of 2% to 3%.

For example, Danielle Park argues in her book Juggling Dynamite that it is somewhat disingenuous to look at only missing the best performing months: if the calculator looked at missing some of the worse-performing months, it would make the market-timing approach look relatively better. There would seem to be better ways to argue the case for either “time in the market” or “timing the market.”

Don Vialoux of the Tech Talk blog thinks the indexes will break below the lows but believes the “chances of a sharp decline on a break below support are relatively low.” That’s because “momentum indicators already are substantially short-term oversold.” For example, the Relative Strength Indicator (RSI) for the S&P 500 and S&P/TSX Composite Indexes are at the 30 level.

On the other hand, Jeff Pierce of the Zentrader blog writes that the decline thus far “seems to be building steam to the downside.” There doesn’t yet appear to be any signs of the panic usually associated with bottoms, in his opinion. For example, the VIX Index remains quite far below its spike of November.

 Charts courtesy of StockCharts.com www.stockcharts.com and Tech Talk Blog

Another reason for do-it-yourself investing. And a second reason. And a third.

 A clear winner in the RRSP vs. TFSA debate.

Shopping for corporate bonds like going into a candy store.

More love for bonds.

Special report on self-directed investing.

Eliot Spitzer’s thoughts on salary caps for CEOs

Deaves on the bear market: “I hear some advisors saying you should sell stocks if you are feeling apprehensive. I don’t agree. It’s a lousy time to cash out. It’s hard to image the markets going much lower. If you are young, there is a lot of time left to recover and get back on track. People in their mid-fifties or older who did not diversify properly may not, unfortunately, have time to recover fully. Be sure to pay attention to asset allocation.”

Recommended reading in behavioral finance area: “There is a good, easy-to-read survey book called Investment Madness: How Psychology Affects Your Investing . . . And What To Do About It, by John R. Nofsinger. I enjoyed reading it and many others will too,” said Deaves.

If you need help finding out what kind of investor you should be, you can go to Deaves’ investorgauge.com website and take his InvestorGauge Questionnaire, “a self-assessment tool for investors made up of 50 questions chosen according to the latest investment research.” It generates personalized reports on your investment knowledge, risk tolerance, investment personality and investment temperament. “Knowledge of these personal attributes will be very useful to determine the investment style that is right for you.”

If you had invested for periods longer than 10 years, the average annual returns move in closer to the mean. For example, for holding periods of 25 years (588 observations), annual returns were as high as 17.3% and as low as 7.3%, with a tendency to 12.2%.

If you had invested for periods shorter than 10 years, your chances of losing money are material. Take rolling 12-month periods. There were 670 of them from 1934 to 2007, and 30% incurred losses. You could have earned as much as 83% or lost as much as -49.5%, with a tendency to 12.8%.

These online calculators can be useful. Note, however, the Ativa.com calculator does not go back to the 1920s. If it had, it’s possible some of the 10- and 15-year periods may have shown some negative returns.

The focus is on do-it-yourself investors. What I like is the way the author scours the Internet for information, tools and sources. Most posts are like chapters in a book on how to become a better DIY investor – which makes the blog worth reading all the way back to its beginning in May of 2008.

It’s written by Jean Lesperance, the 50s-something, Ottawa native who resides in Scotland most of the year and writes another blog called Canadian Financial DIY blog. He started writing HowToInvestOnline when he was approached last spring by an ad agency to do a blog for discount broker BMO InvestorLine (see link from the home page).

Unfortunately, during the bull market that ran to early 2008, many people thought they were diversified if they spread their 70% to 90% equity allocation by geography, industry, and market cap. So now diversification is taking a bit of an unwarranted rap on the knuckles.

Activa also has a calculator showing the impact of diversification over bear/bull cycles in the stock market since 1968. For the most recent cycle, from September, 2000 to May, 2008, Activa’s diversified portfolio finished 53% higher, while the all-stock portfolio finished 48% higher. The all-stock portfolio may have raced ahead during the bullish phase but wasn’t able to compensate for the huge losses incurred during the bearish phase.

However, during the previous six bear/bull market cycles back to 1969, the all-stock portfolio ended up higher in four of them. So, being diversified doesn’t always win. Whether you go with a stock-intensive or diversified portfolio would seem to be more a matter for risk preference. And of course time period is important too: it is generally believed stock-intensive portfolios would be suitable for young persons saving for retirement. Endnote: Activa’s calculator used total return U.S. indexes (and 10-year government bonds).

This same psychological tendency toward overconfidence is said to afflict active investors (at least before the bear market of 2008 came along). And like other groups, the tendency toward overconfidence leads to greater risk taking, which in the stock market manifests as over-trading and under-diversification.

Over-trading: Barber and Odean published a 2000 paper that examined the trading histories of 60,000 U.S. investors at discount brokerages between 1991 and 1996, segmenting them into five groups according to frequency of trading. They found each quintile earned nearly the same gross return, but when trading costs were factored in, net returns went down as trading activity went up.

Under-diversification: A 1995 research paper by Morgan looked at the portfolios of over 3,000 U.S. individuals. Of those invested in stocks, one-stock portfolios were most common. Only 5 per cent held more than 10 stocks.

(Thanks to Richard Deaves’ book ‘What Kind of an Investor are You” for pointing out these studies).

But it would be a mistake to see the government as powerless. As the recession deepens, it gives the Federal Reserve more scope to monetize debt and other assets. The amounts of new money created will be large, and inevitably will bring out louder prophecies of hyperinflation and other doom-and-gloom scenarios.

But before the wave of new purchasing power reaches an inflationary threshold, the economy has to experience an upswing and reach full employment. That could be another two years or so, given the customary lags – lots of time to make a good return in the stock market. The SPDR S&P 500 ETF (SPY) could very well be 20% to 30% higher by the end of 2010 or at least by mid-2011.

Presumably, as the economy approaches full employment, the Federal Reserve will act to withdraw liquidity from the economy. It won’t let the economy shoot off into galloping inflation, as many of the gloomy prognosticators seem to be overlooking. Granted, the ride will not be smooth.

As for a collapse in the U.S. dollar and soaring U.S. interest rates, they are not likely to happen while emerging countries continue to repress their currencies in efforts to boost exports to the U.S. and the developed countries. That means they should have accumulations of U.S. dollar reserves to recycle back into U.S. bonds and other assets.

He had a contrarian perspective. “I just don’t see the TFSA as such a big deal right now,” he said. Do the math: “If you invest $5,000 in a TFSA, and the money is placed in a low-risk GIC paying 5% (at highest rates) for 12 months, then you get $250 of interest at the end of the first year. That is tax free, so you save $125 (in the highest 50% tax bracket) in the first year.” 

Asks Milevsky: “Hundreds of news articles and stories over the equivalent of a nice dinner and a movie for two?” Some will say that you can get more if you invest in stocks at 8% or more. But he rejects using equity returns because they can just as easily be -8% in 2009. The true comparison requires the risk-free interest rate, in his view.

For such a small benefit “why not give every Canadian a tax credit for $125 and save the financial institutions, their I.T. departments and the rest of us the implementation hassle?” Milevsky suggests (i.e. avoid more bureaucratic costs cutting into what Canadians earn on their savings).

“Sure, maybe in 5 years from now the sums of money I can shelter will be large enough and the compounding impact will be much greater so that the tax savings becomes worth the hassle of going to the bank, standing in line, keeping track of yet more paperwork, opening an account, etc,” Milevsky admits.

But … “let’s see how this program changes over time. Tax policy can be just as fickle as financial markets. What limits will politicians impose on the TFSA by the time this becomes valuable?” (i.e. more regulatory risk for Canadian savers).

Legendary investor Jim Rogers recently told reporters he is bullish on the airline industry. The many bankruptcies, cutbacks, and mergers are a sign of a bottom, he says. The industry has cleaned up the overcapacity problem that has made it such a bad investment over the last 10 years (during which the AMEX Airline Index has lost 90% of its value).

Meanwhile, the plunge in oil prices has lowered fuel costs substantially. One analyst estimates that the top ten airlines will save about $20 billion (US) in 2009, which more than offsets the $6- to $8-billion (US) hit to revenues expected from the recession.

Companies are admitted into the Claymore/NYSE Arca Airline ETF if they have at least half their sales from flying passengers, a market capitalization greater than $100 million (US) and daily trading volumes averaging at least $1 million (US) a day. On this basis, 25 companies presently make it into the ETF.

The weighting formula starts off with a 70% allocation to U.S. stocks and 30% to non-U.S. stocks. The top three U.S. carriers (by market cap), Continental, Southwest, and AMR, each get 15%. The top three international carriers, Lufthansa, Singapore Airlines and Air France, get 4.5% each. Rebalancing is done quarterly.

This will be a volatile ETF. Still, there is potential for more than a doubling in value. Maybe it could be a pick for the aggressive investor with a mad-money portfolio in or outside a TFSA?

This is a breakthrough in making ETFs more convenient. Until now, index mutual funds were the only way for index investors to reinvest dividends without charge. Now they can DRiP with Claymore ETFs, which have much lower annual expense ratios.

Claymore will also be offering commission-free, dollar-cost averaging through its Pre-Authorized Cash Contribution Plan (PACC Plan), as well as commission-free, systematic withdrawals through its Systematic Withdrawal Plan (SWP). Those features will be quite convenient too.

The Canada Deposit Insurance Corporation is to be strengthened (increased borrowing capacity plus a bridge-financing facility) to enable it to respond more effectively in the event a member institution becomes insolvent. The government also “proposes to designate tax free saving accounts (TFSAs) as a separate category of deposits insurable by the CDIC.” I thought they already were, but this sentence in the budget document suggests they weren’t.

The federal government intends to push forward with a national securities regulator. One step is to fund an office to assist with the transition. Another is to table securities legislation based on the recommendations of the Hockin panel, for willing provinces.

There are some new measures to help consumers of financial products. Specifically, the government plans to strengthen disclosure requirements for credit-card issuers. Grace periods to pay off credit-card balances are to be subjected to a minimum requirement. Mortgage insurance provided by banks is to be made more transparent and affordable.

A task force on financial literacy is to be struck, to make recommendations to the Minister of Finance on a cohesive national strategy for financial literacy. To launch in the spring, representatives will be selected from the business, educational, volunteer, and academic communities. Maybe they’ll pick one or two of Canada’s financial bloggers. They’re doing a fine job already contributing to financial literacy. Thousands of Canadians turn every day for illumination and guidance to bloggers like Canadian Capitalist, Michael James on Money, Canadian Personal Finance, Where does all my money go, and Canadian Financial DIY.