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Shortly before Benjamin Graham died, he gave an interview reflecting on all he had learned during his 60+ year career. The interview is titled A Conversation with Benjamin Graham by the Financial Analyst Journal. Graham’s profound answers offer powerful lessons for investors still to this day.
During the course of Benjamin Graham’s career, he published a vast number of articles, speeches, and reports which documented his investment principles. By far, the most referenced of these publications are two time-tested books, Security Analysis and The Intelligent Investor.
But, none of Graham’s publications are more relevant to individual investors than his last interview. As Daniel Webster famously said, “Wisdom begins at the end.”
A Conversation With Benjamin Graham
This article is the second of a multi-part series called, Lessons from A Conversation with Benjamin Graham. In this series, we look at each of Graham’s answers and see how they are relevant to investors today.
Part 2 breaks down five questions from A Conversation with Benjamin Graham. The questions focus on Graham’s view of both institutional and individual investors’ chances of succeeding in the market.
Question: Can the average manager of institutional funds obtain better results than the Dow Jones Industrial Average or the Standard & Poor’s Index over the years?
Ben Graham: No. In effect, that would mean that the stock market experts as a whole could beat themselves–a logical contradiction.
Translation: Graham is taking the question literally and providing a practical answer. By definition, an average investor cannot be above average. This is an important point to consider. A total market index fund will perform based on the average performance of all investors. If you invest in anything other than a market index fund, you are claiming to be an above average investor.
Beating the Market
Question: Do you think, therefore, that the average institutional client should be content with the DJIA results or the equivalent?
Ben Graham: Yes. Not only that, but I think they should require approximately such results over, say, a moving five-year average period as a condition for paying standard management fees to advisors and the like.
Translation: If you claim to be better than average, you better be right. Additionally, if you invest in a managed mutual fund or pay an investment advisor, they better be worth the cost. According to Graham, anyone who can’t beat the market over a five-year period, might as well just invest in a total market index fund. The five-year time frame is a key component to Graham’s answer. He knows that all investment strategies will under perform the benchmark at certain times. Patient investors understand that some successful strategies won’t outperform the market for at least five years.
Question: What about the objection made against so-called index funds that different investors have different requirements?
Ben Graham: At bottom that is only a convenient cliche or alibi to justify the mediocre record of the past. All investors want good results from their investments, and are entitled to them to the extent that they are actually obtainable. I see no reason why they should be content with results inferior to those of an indexed fund or pay standard fees for such inferior results.
Translation: Some advisors and institutional managers claim that index funds aren’t for everyone. They justify added fees and sub par performance by saying that each investor has unique “requirements”. Graham brushes this off as nonsense. He reiterates his position that there is no excuse for under performing the market.
Individual vs. Institutional Investors
Question: Turning now to individual investors, do you think that they are at a disadvantage compared with the institutions, because of the latter’s huge resources, superior facilities for obtaining information, etc.?
Ben Graham: On the contrary, the typical investor has a great advantage over the large institutions.
Translation: A widespread belief is that institutional managers have an advantage over individual investors. It’s intuitive to think that large investment firms will perform better because of the resources available to them (teams of analysts, sophisticated software, access to management, etc.) Graham disagrees.
Ben Graham: Chiefly because these institutions have a relatively small field of common stocks to choose from–say 300 to 400 huge corporations–and they are constrained more or less to concentrate their research and decisions on this much over-analyzed group. By contrast, most individuals can choose at any time among some 3000 issues listed in the Standard & Poor’s Monthly Stock Guide. Following a wide variety of approaches and preferences, the individual investor should at all times be able to locate at least one per cent of the total list–say, 30 issues or more–that offer attractive buying opportunities.
Translation: Here, Graham explains his counter intuitive claim that an individual investor “has a great advantage over the large institutions.” He is clear that the more money an investor has, the more disadvantaged he is. This is because large investors have a smaller selection of stocks to choose from. They can can only invest in large-cap companies. Small investors on the other hand, can invest in any sized company. Additionally, bigger companies are less likely to be mis-priced due to their popularity.
Graham’s answers to the above questions from A Conversation with Benjamin Graham show how confident he was that individual investors could succeed on their own. There is no need to pay professional money managers. There’s no reason individual investors can’t match or beat the market by themselves.
Although the topic of these questions revolve around index funds, you’ll see in part 3 which simple strategies Graham recommended for individual investors.
Mitchell Mauer is the Founder of TheStockMarketBlueprint.com. The Stock Market Blueprint is a site that finds value stocks for investors building long-term wealth. The site’s investment philosophy is anchored in principles established by Benjamin Graham and his most reputable followers over the last 100 years.