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Rupert Hargreaves
Rupert Hargreaves
Articles (941)  | Author's Website |

Revisiting Ben Graham's Asset Allocation Policy

Looking back at the performance of Graham's recommended asset-allocation policy

July 30, 2019 | About:

Benjamin Graham is considered to be the foundr of value investing and one of the influential investment teachers of all time. His two books, "Security Analysis" and then "The Intelligent Investor," educated an entire generation of investors about the benefits of fundamental analysis. He also touted the benefits of why buying stocks cheap is essential if you want to make money over the long term.

Before his work, Wall Street was dominated by gossip and speculation. Fundamental analysis was virtually unheard of in the first quarter of the last century. While some additional books have been written on the topic of fundamental analysis, trading was still dominated by tips and speculators.

Making investing accessible

One of Graham's overriding goals was to make investing accessible for the everyday person. A lot of his writing and interviews concentrated on the idea of helping the average person invest. He tried to come up with some basic formulas and ratios to help the average person allocate their portfolio effectively.

Some of his most insightful comments on this topic come from a 1955 interview with U.S. News & World Report. In the interview, he discussed the investment options for a range of salaries from the "small man, the $45,000 a year" person to the $450,000 person and $900,000 a year person. For the "$45,000 a year" person he recommended:

"...it is possible for the small man, the $45,000 a year man who wishes to build up an interest in common stocks out of his modest savings to do so reasonably well by following one of these accumulation programs in the investment fund area."

Meanwhile, for the wealthiest bracket he advised:

"...the $450,000 man would feel that he would like to look over the situation in investments at least and consider making decisions of his own in the kind of securities that he wants. The amount of money that he has would make it worthwhile to give it thought and considerable care. 'I'm not so sure that this man would necessary do any better than he would do if he bought mutual fund shares, but 'it's more natural and more interesting for him to do other things."

In addition to this advice, the dean of value investing also believed that no investor should have more than 75% of their wealth in stocks. He recommended that investors should use a 50-50 stock-bond allocation as a baseline, and then shift as far as 25-75 in either direction, based on market conditions. Discussing the strategy in "The Intelligent Investor," he recommended:

"The sound reason for increasing the percentage in common stocks [beyond 50%] would be the appearance of 'bargain price' levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high."

The key phrase here is "dangerously high." In Graham's work, he frequently talked about the level of the market, and when he thought it was over or undervalued. All of these guesses turned out to be incorrect over the long term. So, like so many things in investing, there is no sure-fire way to work out if the market is "dangerously high." Still, Graham also believed that stocks became unattractive as an investment when the stock earnings yield was "twice the current interest rate on highest grade industrial bonds."

Based on this statement, let's take a look at the performance of Graham's asset allocation set-up for the previous 10 years.

Asset allocation

Interestingly, thanks to the ultra-low interest rates policy of central banks around the world, stocks have not hit this "dangerously high" level as defined by Graham since 2009 (as defined by the S&P 500 earnings yield and the Moody's Seasoned Aaa Corporate Bond Yield).

With this being the case, if we take the base-case asset allocation and do 50-50 stocks and bonds, with the stock component defined by an S&P 500 index tracker and the bonds by iShares iBoxx $ Investment Grade Corporate Bond ETF, a portfolio constructed following Graham's rules would have returned 10.2% compounded annually over the past decade, with a maximum drawdown of 12.5%. Just the S&P 500 alone would have returned 14.2% with a maximum drawdown of 18.2%.

Looking at these figures, it is interesting to see that even today, Graham's asset allocation strategy still seems sensible for investors.

Disclosure: The author owns no share mentioned.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

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