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An extraordinary guidebook for investing your money

Warren Buffett calls it one of the most important books ever written in the field of investing. The Intelligent Investor by Benjamin Graham was first published in 1949, but even today it is as valuable as ever. It is a must read if you want to get serious in investing.

Securities exchanges are among the most efficient markets you can think of. That being said, definitely, every investor should know the theoretical foundations of finance. However, even security markets are not always efficient. In The Intelligent Investor, Benjamin Graham, The Godfather of value investing, provides mind-changing ideas on how to look on the world of finance in practice.

Even though the idea is not revolutionary, e.g., Keynes had similar thoughts, I like how Graham stresses the difference between investing and speculating. That is, investing refers to those who see themselves as business owners with the right to participate in a series of prospective cash flows provided by that same business. That being so, an investor is not interested in the day-to-day fluctuations of market prices. Instead, he may hold an investment forever while consuming from its periodic earnings. If he reinvests, he can even build a fortune over time - thanks to compounding interest. On the other hand, a speculator is someone who purchases a security only with the goal to resell on short notice. Unlike investors, speculators are not interested in the long-term success of the business.

I also agree with his view to split investors into two main groups: the professional and the passive ones. Whereas the professional investor brings a lot of knowledge and resources to the game of active security selection, the passive investor does not. For the passive, the best strategy is to hold the market portfolio. For the professional investor, Graham claims, the best strategy is to rely on very view businesses he truly understands. In fact, he recommends quite the opposite from the concept of diversification applicable to the passive investor.

Indeed, in finance theory, given some assumptions, you can prove that idiosyncratic risk can be eradicated when holding a well diversified portfolio of assets - the so called market portfolio. Hence, when following Grahams advice to the professional investor, his portfolio would still carry idiosyncratic risk - simply because it is not diversified. Graham argues that the professional investor would not decrease his risk through diversification but rather due to his knowledge and effort about the businesses he owns, which enables him to identify undervalued companies. That being so, he must be able to identify a company that sells for an amount way below its intrinsic value (plus some Margin-of-Safety).

In my opinion, Graham is right in the sense that there are some conditions under which one might be able to find investment opportunities with a positive net present value. He argues that those opportunities arise thanks to Mr. Market - a "guy" that is really driven by emotions and yells from second-to-second a different price for the same asset. Maybe Mr. Market is even drunk?! This view might sometimes be true and is widely accepted - even by some leading scientists such as Robert J. Shiller. However, in most cases, markets are indeed efficient. That said, when you come up with a different price for a business other than the market you would need to have very good argument for it. Unfortunately, there is this bias which makes people think they have superior information about a particular assets, which Mr. Market is not already considering in its price.

This book, to some extent, contains the principles of Warren Buffett, one of the greatest investors of all time, who successfully managed to gain higher return than the market over multiple periods. If you are keen to invest rather than speculate, I highly recommend you read this masterpiece here*.