Hello Steemians,
The chapter that we will be looking at today deals risk management and future expectations in the markets. The essence of what Graham talks about is that the intelligent investor must never base his future expectations of market performance solely on past performances. He also forecasted the bear market two years ahead of the market crash. Many prolific professors and investment gurus make all sort of statements which could mislead us. During the 2000’s many pundits were quick to say the tech stocks are not overvalued and the market isn't risky simply because the prices have soared. The NASDAQ Index at the time $4446 crashed to a low of $1300 erasing all its previous 6 year of gains. Many, including myself had the same ideology about the crypto market and time has proven us all wrong with a 85%+ correction.
It is important for us to remember that as prices rise, so do the risks. An Intelligent investor must be aware of his or her decision making and have a plan for times they are uncertain about the market conditions.
The higher they go the harder they fall
Scepticism is always useful when prices are high. Graham urges us to remember that the value of any investment is the price you pay for it. The amount of value a business or a technology can create is always finite, therefore the price we pay for them must remain finite. Graham’s advice couldn’t have been put any better:
By the rule of opposites, the more enthusiastic investors become about the stock market in the long-run, the more certain they are to be proved wrong in the short-run
The intelligent investor also does not seek market advice from “experts” who made false predictions. This can be associate with the way the financial crisis was set up, the dot-com bubble was created, or the airline industry was propped up as the best investment option. The same people who were so sure about their beliefs were the ones brutally destroyed by the markets. Hence, don’t take the expert’s advice and do your own research. One thing we must all agree to is no matter what we expect, the markets always have their own way of surprising us.
Graham believes that securities rise due to three factors, so always analyze which factor is responsible for the price hikes:
- Real growth (increase in companies’ earnings and dividends)
- Inflationary growth (increase due to higher prices)
- Speculative growth (the public’s appetite to bet on the markets)
When in Doubt Be Cautious
Graham’s final advice to investors is to be rational and sensible. If something is too good to be true, it probably is. He emphasizes that the intelligent investor is always responsible for his decisions. In that respect, if you are drawing different conclusions from various sources, choose the cautionary path. If you ever find yourself in a situation where decision making is becoming harder follow Graham’s policy:
- Do not borrow money to hold your positions
- Do not increase the ratio of your intended invested capital to your overall wealth
- Bring your risky asset holding down (by 50%) and use the funds for capital gains tax, low risk investments (bonds), and cash holdings
Conclusions
In final words, don't be the expert who is so sure about the future of the markets, don’t think the markets can go up forever, never lose your hope as it “always springs eternal”, and remain humble, don’t chase the markets looking for unrealistic gains.
Key Takeaways:
- The lower your future expectations from the markets, the better the results. Lower your expectations
- Markets tend to brutally correct those who are most certain about their view; don’t be the one who risks everything just to be proven right
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