The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor

But first, a chapter of cautionary advice. Graham is nothing if not cautious, after all. The focus here is on things that even enterprising investors should avoid.

Chapter 6 - Portfolio Policy for the Enterprising Investor: Negative Approach
So, what should you avoid?

First, avoid junk bonds. If they have anything less than a stellar bond rating, don’t bother, even if they appear to return very well. Junk bonds put your principal at risk, and the point of buying bonds is to have a safe portion of your portfolio.

Second, avoid foreign bonds. Here, there are stability issues, and it’s often hard to adequately judge the risk of buying bonds from government and private entities operating under rules unfamiliar to you. Today, arguably, Graham would be okay with buying bonds within the European Union, but I would guess Graham would avoid anything outside of that.

Third, avoid preferred stocks. Preferred stocks are ones that have a higher priority in the event of a liquidation of the business, but often come at a premium price. Almost always, Graham doesn’t feel these are worth any sort of premium. Of course, in the United States, preferred stock is generally not sold directly to individual investors, only to large institutions, so it’s largely a moot point.

Finally, avoid IPOs. To put it simply, new issues do not have any track record upon which to adequately judge the company. The “hype” of an IPO is all you really have to judge the issue on. Instead, let others jump into that feeding frenzy and wait until time has shown which companies swim and which ones sink.

Those are some good rules for anyone to follow, particularly if you’re concerned about not losing the money you invest. Most of these investments have a pretty significant amount of risk and in Graham’s world, one shouldn’t put the principal at undue risk.


Commentary on Chapter 6
Zweig looks at modern examples of all four of these cases and largely comes to the same conclusions as Graham: they’re quite risky and probably not worth it for the average investor. The only caveat that Zweig makes is that there could be room for a mutual fund of junk bonds in a large and diverse portfolio, but it should be considered risky and not be considered anywhere close to a “safe” portion of the portfolio.

Zweig also covers day trading here, describing it as something for most people to avoid. Why? In a world where trading is completely free and trades could be always executed without delay, many people could make a solid income from day trading.

But that’s not the real world. Brokerage fees can eat up a lot of one’s gains, as can trading delays. This forces day traders to walk a tightrope - it becomes a high risk game, and that’s not a game for an investor with any conservative streak. Zweig almost writes it off as gambling, in fact.

So, in short, avoid junk bonds, foreign bonds, IPOs, and day trading and you’re off to a good start in Graham’s world.


Ref: The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor