Chapter 8 of Benjamin Graham's famous book, "The Intelligent Investor," provides an excellent guide for how investors should approach the market in times of volatility. In the chapter titled, "The Investor and Market Fluctuations," Graham explained the difference between an investor and a speculator, and how investors should approach the market on a day to day basis.
Graham on Mr. Market
In the chapter, Graham introduced his "Mr. Market" persona, a fictional character meant to personify the stock market. "If you are a prudent investor or sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise?" Graham wrote.
Graham advised readers to view publicly traded securities as private businesses, because private businesses do not have a daily quotation. On this topic, he wrote what has since become one of the single most influential paragraphs of his career:
"The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to is and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared that mental anguish caused him by other person's mistakes of judgment."
Graham then went on to give an example of the "dark depression days of 1931 to 1933." He explained that during this time, there was a psychological advantage to owing businesses that had no market quotes, citing real estate as an example. Real estate owners that continued to pay their mortgages through the bear market of 1931 to 1933 "were able to tell themselves that their investments had kept their full value, there being no market quotations to indicate otherwise."
Learning from Graham's advice
There are a couple of lessons we can learn from this advice from the mid-1900s. For a start, investors are putting themselves at a disadvantage if they monitor stock prices every day. The most significant advantage individual investors have over institutional investors and business owners is the ability to act quickly and take advantage of market dislocations when they arise.
As Graham explained, if you let the market dictate your actions, this advantage quickly becomes a disadvantage. If you are struggling to deal with market volatility, then it might be better to avoid assets with a public quotation altogether. Research shows that public equities produce a better return than most other asset classes over the long term.
However, if you're going to sell every time the market falls 10% or more, you're unlikely to benefit from the wealth-creating power of the stock market over the long-term. Therefore, it might be better to find other assets to own.
While Graham's words are invaluable for volatile markets, they should also come with a warning.
Graham made it clear that investors should not allow themselves to be scared by "unjustified market declines." Sometimes, stock price declines are justified, especially if a company loses all of its revenue overnight. That's something to keep in mind. In these situations, holding onto an investment even though the investment case has changed can be a terminal mistake.
Unfortunately, there's no set guide to distinguish between an unjustified market decline and one that is justified. We can only make an educated guess, based on research and experience. No one ever said investing was easy.
Disclosure: The author owns no share mentioned.
Read more here:
- Benjamin Graham: How to Find Bargain Stocks
- Are Berkshire Hathaway's Shares Cheap?
- Seth Klarman's Baupost Is Buying
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
