This is the eighth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the seventh chapter, which is on pages 155 to 178, and the Jason Zweig commentary, on pages 179 to 187.

If you’ve been paying attention the last few weeks, you’ve probably observed that Ben Graham has a lot of ideas about what you should avoid. Defensive investors should avoid everything but large, prominent companies with a long history of paying dividends. Even enterprising investors should avoid junk bonds, foreign bonds, preferred stocks, and IPOs.

To put it simply, Graham doesn’t like risk. It comes through time and time again in every chapter of the book - do the footwork, minimize risk, and don’t swing for the fences.

So what kind of real-world investing does that lead to? Graham finally gets down to actual tactics here, finally pointing toward some specific investment choices that he actually supports! At last!

Chapter 7 - Portfolio Policy for the Enterprising Investor: The Positive Side
Graham says that there are four clear areas of activity that an enterprising investor (read: not an ultra-conservative investor) should focus on:

1. Buying in low markets and selling in high markets.
Graham says, in essence, that this is a good strategy in theory, but that it’s essentially impossible to accurately predict (on a mathematical basis) when the market is truly “low” and when it’s truly “high.” Why? Graham says that there’s inadequate data available to be able to accurately predict such situations - he basically believes fifty years of data is needed to make such claims, and as of the book’s writing, he did not believe adequate data was available in the post-1949 modern era. Note, though, that Graham returns to the notion of high and low markets in the next chapter.

2. Buying carefully chosen “growth stocks.”
What about growth stocks - ones that are clearly showing rampant growth? Graham isn’t opposed to buying these, but says that one should look for growth stocks that have a reasonable P/E ratio. He wouldn’t buy a “growth stock” if it had a price-to-earnings ratio higher than 20 over the last year and would avoid stocks that have a price-to-earnings ratio over 25 on average over the last several years. In short, this is a way to filter out “bubble” stocks (one where irrational exuberance is going on) when looking at growth stocks.

3. Buying bargain issues of various types.
Here, Graham finally gets around to the idea of buying so-called “value stocks.” For the most part, Graham focuses on market conditions as they existed in 1959, pointing towards what would constitute value stocks then. What I found most profound, though, is a brief bit on page 169. Here, Graham discusses “filtering” the stocks listed by Standard and Poor’s (essentially a 1950s precursor to the S&P 500) and identifying 85 stocks that meet basic value criteria, then buying them and finding that, over the next two years, most of them beat the overall market.

That’s an index fund, my friends. Graham had basically conceived of the idea in the 1950s - it worked then, and it works now.

4. Buying into “special situations.”
Graham largely suggests avoiding “topical” news as a reason to buy or sell, mostly because it’s hard for investors to gauge how exactly such news will truly affect the stock’s price. Instead, one should simply file away interesting long-term news for later use if you’re going to evaluate the stock. For example, recalling that a company is still paying off an incurred debt from ten years ago and that debt is about to be paid off might be an indication of an upcoming jump in profit for the company - and a possible sign of a good value.

Commentary on Chapter 7
Zweig provides a ton of supporting evidence that market timing doesn’t really work, and that “examples” of market timing that are often used to show how good it can be are cherry picked using the amazing power of hindsight.

He makes a similar argument about growth stocks, saying that there are often periods where growth stocks appear to be taking off like a rocket, but that it’s impossible to know where the top of that rocket ride is. He provides several examples of this and largely seems to agree with Graham that the only growth stocks a person should invest in are ones that are truly sound as a business and not merely the beneficiaries of a lot of hype. How can you do this? Keep a very close eye on the real business numbers of any growth stock you own.

In the end, Zweig argues that the best solution for most investors is pretty simple: diversify, diversify, diversify. Don’t put all your eggs in one basket, ever. Instead, buy lots of different stocks from lots of different industries and from lots of different markets (foreign and domestic).

Next Friday, we’ll take a look at Chapter 8: The Investor and Market Fluctuations.

This is the seventh in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the sixth chapter, which is on pages 133 to 144, and the Jason Zweig commentary, on pages 145 to 154.

As we’ve learned over the past two weeks, Graham’s view of a conservative investor is very conservative. Focus primarily on big, blue chip stocks that pay a dividend and counterbalance that with roughly an equal amount of bonds. Very conservative, indeed.

But what about those of us who are less conservative and want to seek out other investments? After all, isn’t The Intelligent Investor supposed to be a guide to value investing, not just “buy blue chips and wait”?

Graham starts to head down this path here as he turns his sights from the very conservative investor to the … less conservative investor, the type of person who would actually follow value investing principles and seek out investments that show every sign of being undervalued - and then invest in them.

But first, a chapter of cautionary advice. Graham is nothing if not cautious, after all. The focus here is on things that even enterprising investors should avoid.

Chapter 6 - Portfolio Policy for the Enterprising Investor: Negative Approach
So, what should you avoid?

First, avoid junk bonds. If they have anything less than a stellar bond rating, don’t bother, even if they appear to return very well. Junk bonds put your principal at risk, and the point of buying bonds is to have a safe portion of your portfolio.

Second, avoid foreign bonds. Here, there are stability issues, and it’s often hard to adequately judge the risk of buying bonds from government and private entities operating under rules unfamiliar to you. Today, arguably, Graham would be okay with buying bonds within the European Union, but I would guess Graham would avoid anything outside of that.

Third, avoid preferred stocks. Preferred stocks are ones that have a higher priority in the event of a liquidation of the business, but often come at a premium price. Almost always, Graham doesn’t feel these are worth any sort of premium. Of course, in the United States, preferred stock is generally not sold directly to individual investors, only to large institutions, so it’s largely a moot point.

Finally, avoid IPOs. To put it simply, new issues do not have any track record upon which to adequately judge the company. The “hype” of an IPO is all you really have to judge the issue on. Instead, let others jump into that feeding frenzy and wait until time has shown which companies swim and which ones sink.

Those are some good rules for anyone to follow, particularly if you’re concerned about not losing the money you invest. Most of these investments have a pretty significant amount of risk and in Graham’s world, one shouldn’t put the principal at undue risk.

Commentary on Chapter 6
Zweig looks at modern examples of all four of these cases and largely comes to the same conclusions as Graham: they’re quite risky and probably not worth it for the average investor. The only caveat that Zweig makes is that there could be room for a mutual fund of junk bonds in a large and diverse portfolio, but it should be considered risky and not be considered anywhere close to a “safe” portion of the portfolio.

Zweig also covers day trading here, describing it as something for most people to avoid. Why? In a world where trading is completely free and trades could be always executed without delay, many people could make a solid income from day trading.

But that’s not the real world. Brokerage fees can eat up a lot of one’s gains, as can trading delays. This forces day traders to walk a tightrope - it becomes a high risk game, and that’s not a game for an investor with any conservative streak. Zweig almost writes it off as gambling, in fact.

So, in short, avoid junk bonds, foreign bonds, IPOs, and day trading and you’re off to a good start in Graham’s world.

Next Friday, we’ll take a look at Chapter 7: Portfolio Policy for the Enterprising Investor: The Positive Side.

Recently, I was leafing through my copy of Michael Mihalik’s excellent personal finance book Debt Is Slavery (one of the very few I’ve actually kept).

I was working through something of a problem in my mind, one that I wasn’t quite sure how it fit in the context of good personal finance management. When I think back to the happiest time in my life, I think about the honeymoon I spent with my wife - the most expensive two weeks of my life.

My wife and I went to England and Scotland for our honeymoon in the summer of 2003. For a week, we stayed in a hotel with a nice room overlooking Hyde Park in central London, about half a block from the Royal Albert Hall and just a short walk from Westminster Abbey and Buckingham Palace. Later, we spent a few days in Manchester, followed by a few days in Inverness, along with stops in Bath and a few other random places around the country.

I don’t even want to speculate how much the entire trip cost, but I can say without a doubt that it was the most expensive trip of my life. It was also the most memorable two weeks of my life. I remember so much of it with a warm, loving glow - even the pictures seem to possess a certain magic.

On the surface, this would seem to be an argument against much of what I talk about on The Simple Dollar. From my own experience, the most expensive period in my life was also the happiest.

But as I flipped through Debt Is Slavery, the answer to my problem slapped me right in the face on page 39:

When was the best time of your life?

I would guess it’s something like:
+ The idyllic two weeks at summer camp when you were a child.
+ The two month backpacking trip across Europe.
+ The trip to Mazatlan for spring break.
+ The winter you spent at Sun Valley as a ski instructor.
+ The family road trip across the United States when you were 12.

What’s common about those experiences?

+ You had the freedom to do whatever you wanted.
+ You had few, if any, obligations.
+ You were footloose and fancy-free.
+ You weren’t burdened down with STUFF.

The answer to my very problem was right there in front of me. My honeymoon wasn’t a great memorable time because we spent it in such a fancy place. It was memorable because we spent it together, doing whatever we felt like doing, with only a couple of suitcases to worry about.

We were a continent away from any worries in our lives. This was following a period in which I had worked eighty hour weeks trying to create a product that had just gone live a month or two before our wedding. While we were in England, there were no middle of the night calls. There were no emergency tasks that had to be done.

There was just me, my wife, and a lot of simple and enjoyable things.

Looking back now, I realize that the location could have been almost anywhere and it still would have been the best two weeks of my life. We could have just thrown two changes of clothes into the back of our car and driven away from the wedding and it would have been the best two weeks of our lives.

When you consider it took us almost four years to pay off that trip, I somewhat wish we had just taken the simpler trip. We would have still had the freedom, togetherness, and lack of obligations, but without having to come home to that huge bill.

Great memories don’t come from expensive trips or meticulous planning. They come from spending time with little obligation other than to enjoy yourself.

This is the sixth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the fifth chapter, which is on pages 112 to 123, and the Jason Zweig commentary, on pages 124 to 132.

There’s one big underlying theme to this book that I didn’t expect. Yet, it keeps coming to the forefront again and again. It’s the one point that I believe Graham wants people to take home from this book.

Strong, thorough research is the most important part about owning stocks.

If you can’t - or aren’t willing to - put in a lot of time studying individual stocks, identifying ones that genuinely have potential to return good value to you over time, and keep careful tabs on those individual stocks, then you shouldn’t be investing in stocks.

Over and over again, Graham makes this point, in both obvious and subtle ways. He’s a strong, strong believer in knowing the company. If you don’t have clear, concrete reasons for buying a stock, then you shouldn’t be buying that stock, period.

What if you don’t have that time? This book was written before the advent of index funds, but I tend to think that broad-based index funds can be a reasonable replacement for the stock portion of your portfolio.

Chapter 5 - The Defensive Investor and Common Stocks
Graham’s advice, then, tends to focus on people who are willing to put in that extra time - and if you’re willing to do that, he has a lot of wisdom to share.

First of all, diversify. You should own at least ten different stocks, but more than thirty might be a mistake, as it becomes difficult to follow all of them carefully and also seek out new potential stock investments.

Second, invest in only large, prominent, and conservatively financed companies. Look for ones with little debt on the books and ones with a large market capitalization.

Third, invest only in companies with a long history of paying dividends. If a company rarely pays dividends, your only way to earn money from that company is if the market deems the stock to be valuable, and you shouldn’t trust that the market will do so.

Graham seems to point strongly towards the thirty stocks that make up the Dow Jones Industrial Average as a good place to start looking, as they usually match all of these criteria. I’d personally stretch that to include stocks that make up the S&P 500, but the Dow is a great place to find very large blue chip companies that are very stable and have paid dividends for a long time.

Other than that, Graham pooh-poohs many other common strategies. Buying growth stocks? Nope. Dollar-cost averaging? Good in theory, not great in practice. Portfolio adjustments? Be very, very careful - and only do annual evaluations. In short, be very, very wary and play it very, very cool.

Remember, this is Graham’s advice for the defensive, very conservative investor.

Commentary on Chapter 5
So, what does Jason Zweig have to say about all of this?

His big point is that simply “buying what you know” isn’t enough. You shouldn’t buy Starbucks’ stock simply because you drink their coffee. You need to spend the time to analyze the company’s situation, both internally and in the marketplace, and determine whether or not it’s a reasonable value. You can’t get there just by knowing the products they produce.

Zweig seems to generally feel that most people on the ground that are defensive investors are better off just buying mutual funds (preferably index funds) or seeking help from investment advisors, because the work needed to adequately study enough companies to build a good defensive portfolio is beyond what’s available to most people in their busy lives.

For me? I might tinker with individual stock buying, but I think I’d prefer to keep most of my money in index funds, simply because I, too, don’t feel like I have adequate time to really study enough stocks to build a good defensive stock portfolio.

Next Friday, we’ll look at Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach.

People who have been Twitter feed already have heard the story, but I thought I’d share it with all of you.

My three year old son planned for a nice birthday party with his closest friends this past Saturday. We planned everything together - he chose the invitation list (four other children), helped us with invitations, helped with decorations, helped us make the cake - everything. He was incredibly excited by the event and was looking forward to it for weeks.

On the Tuesday before the party, one child said she couldn’t come - there was a family situation that weekend. No big deal.

On Thursday, another child cancelled. Stomach flu.

On Friday, a third child cancelled. Again, stomach flu.

On Saturday morning, a half an hour before the party, the last remaining attendee called and cancelled. Again, stomach flu.

I don’t believe I’ve ever seen a child quite so sad. When my wife broke the news to him that no one was coming to his birthday party, he just stood there for a bit, looking utterly heartbroken, then after a minute or two, he broke down in tears and cuddled with his mom.

It is moments like these when I am at my weakest. I probably would have done anything on earth that my child asked for. What did he want to do? He was content to spend the afternoon playing with his train set - his birthday gift from us. The only thing we did differently was to swap our meals around, saving what was to be the lunch served at his birthday party (his favorite food - homemade pizza with TONS of black olives) to supper instead.

It would have been so easy to just buy him something to console him - to solve a social wound through materialism. Instead, we just turned the day into a close family day, where the four of us spent the whole day together. In the end, I think he was still heartbroken - but I also think he felt loved and reassured, too.

What Is Your Favorite Cultural Activity That Doesn’t Cost Money? This is one of those articles where the article itself isn’t much but it’s generated a bunch of interesting and useful comments. My favorite? Walking the streets of a town and photographing interesting things (architecture, people, events, etc.). (@ carrie and danielle)

Working from Home: What I’ve Learned in 8 Months as a Professional Blogger The stuff J.D. writes about here almost perfectly matches my own experience - and the experience of many people who find a way to work at home with their own microbusiness. (@ get rich slowly)

Holding Yourself Accountable, Part One (Daily), Part Two (Weekly), and Part Three (Long Term) I actually ran across these articles after finishing my article on accountability from yesterday, so this is quite a bit of additional reading on the subject. (@ freelance switch)

Six Simple Steps to Avoid Credit Problems in a Bad Economy Some great, simple advice here that works in a good economy, too. I think many people are panicked right now - it’s important to not lose track of the fundamentals. (@ zen habits)

6 Tips For Small Businesses To Navigate A Tough Holiday Season I forwarded this article to about fifty different people over the last few days. This is good stuff. (@ the digerati life)

Library Fines Got You Down? The Collection Agency is Coming This is one of the drawbacks of using a library - and I’ve been bitten by it a few times. (@ queercents)

This is the fifth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the fourth chapter, which is on pages 88 to 100, and the Jason Zweig commentary, on pages 101 to 111.

A lot of people like to argue that the rate of return you can expect from an investment is directly related to the amount of risk you take on. The more risk you have, the greater the potential return - but also the greater risk if you suddenly need to pull out your money.

I’ve always felt that this is a very limited view of things and that it ignores the effort and intelligence of the investor. An investor who can invest a lot of time studying the market and specific investments and can apply cool reasoning and behavior to his or her investments can get a better return than an investor who just wants to stick his or her money somewhere.

Take index funds, for example. Stock index funds are made up of all of the stocks that meet a certain criteria. If you buy into an index fund, it’ll essentially do as well as the average of all of those stocks. That actually also lowers your risk a fair amount because you’re not tied to the ups and downs of a specific company.

For an investor with limited time to research and understand specific investments - such as me - that’s a great way to invest. However, I know that if I had adequate time to actually study the market and played it cool, I could often (not always, but often) pick specific stocks that would beat this return.

Why don’t I do that? With the amount of money I have to invest (relatively small) and the time it would take to actually do the research and pick the investments (relatively large), it’s not a cost-effective use of my time. Give me index funds or give me death!

This is much the same logic that this chapter provides. Graham also buys into the idea that an intelligent and patient investor has a big advantage over the “gambler”-investor.

Chapter 4 - General Portfolio Policy: The Defensive Investor
Graham opens the chapter defining two different kinds of investors: the “active” investor, which is the kind of investor that actively seeks new investments and invests serious time into studying investments, and the “passive” or “defensive” investor, the kind of investor that wants to invest once (or on a highly regular basis) and just let his or her portfolio run on autopilot.

Regardless of the activity that you apply to your investments, Graham sticks hard with his recommendation from the earlier chapter: 50% stocks, 50% bonds (or a close approximation thereof, with an absolute maximum of 75% in either side). It’s important to remember with a recommendation like that that Graham is very conservative in his investing, dreading the idea of an actual loss in capital. Only in the most dire of down markets (like 2008, for example) would such a portfolio actually deliver a loss to the investor.

Much of this chapter is spent talking about the various types of bonds that a person can buy: savings bonds, treasury notes/bills, municipal bonds, and corporate bonds dominate most of the chapter, with most of their ins and outs described. Graham doesn’t really come to a conclusion about any of them, merely pointing out that there is a huge diversity of options when it comes to the bond portion of your portfolio - some short term, some long term, some free from taxes, some not.

Commentary on Chapter 4
So, how can you tell whether you should be 75% stock and 25% bonds or 50/50 or 25/75? Or somewhere in between? Zweig argues that it mostly comes down to your goals, the stability in your life, your other savings, and your tolerance for risk. The more stable things are and the longer term your goals are, the higher your proportion of stocks can (and probably should) be.

Zweig also covers several additional options for the bond portion that didn’t exist in Graham’s day, such as bond funds, mortgage securities (no, no, no, no, NO!), and annuities. More importantly, Zweig actually looked at holding cash as an investment option in such things as high-interest online savings accounts and CDs. All of these can be a big part of the conservative half of one’s portfolio, sharing space with (or replacing) bonds.

Most interestingly, though, Zweig suggested that buying stocks solely for the dividends might be considered something that could be a part of the conservative side of a portfolio. Zweig points out that many common stocks pay out 3% or more of their value in dividends each year, so if you select a high-dividend stock from a very stable company, it could potentially serve as part of the conservative side of a defensive investor’s portfolio. I don’t know if I agree with this, given the inherent riskiness of owning individual stocks, that companies reset their dividends annually, and that even the most stable of companies can fall apart quicker than you might expect.

Next Friday, we’ll look at Chapter 5: The Defensive Investor and Common Stocks.

Yesterday, I was doing an interview with a newspaper when the interviewer asked me “What’s your single best tip for saving money?”

You would think this would be a “softball” question for me, something I should be able to answer with nearly-automatic ease, but it wasn’t. I paused for quite a while, then came up with a pretty ordinary tip.

After the interview, that singular question stuck in my mind.

What’s your single best tip for saving money?

What does that question really mean?

My first reaction was to offer up a basic platitude like “spend less than you earn,” but that’s not something you go out and do. That’s more of a state of mind, not something you can directly take action with.

On the other hand, I believe that “stop spending to impress other people” is essential advice, but again, it’s more of a change in mindset than a direct action one can take.

What I’m really looking for isn’t merely my best money saving tip, but something else…

What single action was the most effective in your life for saving money?

What one thing have you actually done or specific change have you actually made, in an effort to save money, that has been the most effective in your life?

After all, psychological tips like “stop spending to impress other people” are powerful, but when they’re coupled with direct action, they become transformative.

For me, the single action that has had the strongest positive effect on my spending over the last few years has been discovering my public library.

Before I began to turn my financial life around, I used to spend tons of money on books and DVDs. I would often stop at the bookstore two or three times a week, plus I’d buy more books off of Amazon. Reading was a deeply fundamental part of my life, just as it is now.

When things started to turn around for me, I knew that my reading hobby was one that I’d really have to get under control. I also had a very negative impression of public libraries - in my mind, they were smelly places with poor book selections, and even if they did have your book, it would be beat up and almost disgusting to the touch.

That image, happily, was largely untrue. I was very happy to discover the Ames Public Library, which not only has an amazing book selection, they also have a powerful interlibrary loan system and a great online reservation system, too. I can pick out the books I want to read online and stop by and pick them up when it’s convenient for me.

The library - and I’m now member of several local ones - has saved me a tremendous amount of money over the last few years. Let’s say, hypothetically, it saved me the cost of two books a week (say, $20) plus the cost of storing those books - the shelves, the additional square footage, and so on.

That money seriously added up for me, and it’s drastically changed my spending over the last couple years. Saving $80 or so a month on an expensive book habit turns into $1,000 a year. Just on books.

So I turn the question to you: what single action was the most effective in your life for saving money? It might be something really momentous. It might be something seemingly small and trivial. Whatever it is, please share your tactic in the comments.

The election is over. Where do we go from here? Barack Obama might be President-elect, but that doesn’t mean that everything has suddenly changed in the world.

After two years of presidential campaigning, we wake up in an America that’s really not much different than the one we woke up to yesterday. We’re still (on average) in quite a bit of debt. We’re still (on average) not saving for retirement. We’re still wasting time at work and wasting time in our personal lives. We’re still trapped by the same old fears, and we’re still choosing to limit ourselves based on what others think of our limitations.

Yesterday, America pretty clearly voted for change, for better or worse. But today is when the real change begins, and it begins with you.

Change we can believe in? That’s yesterday’s news. Today, the real change begins: the change within each of us.

What kind of change will that be for you? For me, I’m changing my work habits and my work goals. I’m going full speed ahead on a big project that I intend to give away in a few months. And I’m focusing more on the charities and causes that are important to me.

That kind of change isn’t brought by a politician promising hope. It’s brought from within me and from within you, too.

That’s change I can believe in while leaving the politics at the door.

The Save $1000 in 30 Days Challenge Ramit is creating a list of thirty essential savings tactics that he believes will add up to $1,000 in savings a month for people who really strive for it. I particularly like tip #4, involve your friends. (@ i will teach you to be rich)

On Shaving Equipment This one inspired me because it made me realize how much of an impact I can have as a frugal role model. If I use classic (frugal) shaving equipment and teach my son to do the same, he’ll save money his entire life. (@ gather little by little)

Simple Steps for Organizing a Home Office My home office recently went through something of a remodel that really helped me be more effective at work. (@ unclutterer)

Tipd This site is something of a personal finance link collector. You might find it of interest.

Get Art for $4 Every once in a while, I see something that really inspires me in some fashion. This one inspired me to work on some frugal home decor ideas (similar to this one, except with paint and stencils instead of an engraver). (@ ikea hacker)