2.1. of the strategy is downside protection: while

2.1. The defensive value strategyIn Chapter five of The Intelligent Investor, Benjamin Graham discusses the general portfolio policy that the defensive investor should follow. As stated before, this strategy will likely offer a lower return to the investor but also provide more safety. It is also the strategy that will take less time to implement and can therefore be considered applicable by ordinary people. The first aspect of the defensive strategy regards diversification. Graham recommends applying “adequate though not excessive diversification” to one’s portfolio (114). Specifically, he favors a “minimum of ten and maximum of thirty issues” (114). The main purpose of this aspect of the strategy is downside protection: while one of your investments might fall in market value, others may rise if you have a diversified portfolio with many stocks in it (“Benefits of diversification”). This would not be the case if the investor owned just one stock or a small number of stocks. If that one stock fell, the investor’s entire portfolio would be underperforming. Nevertheless, Graham says “not excessive diversification” because holding too many stocks can make the investor’s portfolio resemble the general market, “making it nearly impossible … to outperform” (“Dangers of Over-Diversifying”).All of the stocks in the investor’s portfolio should be from “large, prominent, and conservatively financed” companies that show a “long record of continuous dividend payments,” concretely about 20 years (Graham 114). This verifies that the stocks are stable and produce goods or services that will likely still be in demand years after the investor buys the stock.Regarding the price-earnings ratio, Graham advocates the price to be a maximum of 25 times the average earnings of the last seven years but “not more than 20 times those of the last twelve-month period” (115). The price-earnings ratio basically “tells you how many times earnings the company is valued” (Research Desk). In other words, it shows the investor how much money he has to pay to receive one unit of money for his investment. Therefore, a low P/E ratio means that you do not have to pay a large amount of money to collect one dollar of earnings while “a high P/E means a costly stock” (Research Desk). However, a low price-earnings ratio can also be “an indication of poor current and future performance” because it shows that investors anticipate poor future growth (“Price Earnings”). By adopting Graham’s recommendation, investors can likely circumvent both the risk of paying too much as well as buying stocks that will show poor growth. To make the strategy easier to follow, Graham also suggests two formulaic components in the defensive strategy: first, he recommends using a simple 50-50 percent to 25-75 percent or 75-25 percent division between stocks and bonds (89). Through a practice of regular rebalancing, for instance, quarterly rebalancing of one’s portfolio, the investor would sell stocks and invest in bonds once the stocks become too pricey and conversely sell bonds once stocks become cheap (Graham 89). Likewise, Graham backs dollar-cost averaging, a procedure “under which an investor devotes the same dollar amount each month to buying one or more common stocks” (118). This way the investor can be “prevented from putting a big chunk of cash with gone-up priced shares or selling with sudden and even prolonged prices-dropping panics” (Fang 7). Furthermore, he also brings up the idea of automating one’s portfolio “by buying the same amounts of all thirty of the issues in the Dow-Jones-Industrial-Average (DJIA)” (Graham 347).


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