CHAPTER 1
Investment versus Speculation: Results to
Be Expected by the Intelligent Investor
This chapter will outline the viewpoints that will be set forth in the remainder of the book. In particular we wish to develop at the outset our concept of appropriate portfolio policy for the individual, nonprofessional investor.
Investment versus Speculation What do we mean by “investor”? Throughout this book the term will be used in contradistinction to “speculator.” As far back as 1934, in our textbook Security Analysis,1 we attempted a precise
formulation of the difference between the two, as follows: “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”While we have clung tenaciously to this definition over the ensuing 38 years, it is worthwhile noting the radical changes that have occurred in the use of the term “investor” during this period.
After the great market decline of 1929–1932 all common stocks were widely regarded as speculative by nature.
(A leading authority stated flatly that only bonds could be bought for investment.)
Thus we had then to defend our definition against the charge that it gave too wide scope to the concept of investment. Now our concern is of the opposite sort. We must prevent our readers from accepting the common jargon which applies the term
“investor” to anybody and everybody in the stock market. In our last edition we cited the following headline of a front-page article of our leading financial journal in June 1962: SMALL INVESTORS BEARISH, THEY ARE SELLING ODD-LOTS SHORT
In October 1970 the same journal had an editorial critical of what it called “reckless investors,” who this time were rushing in on the buying side.
These quotations well illustrate the confusion that has been dominant for many years in the use of the words investment and speculation. Think of our suggested definition of investment given above, and compare it with the sale of a few shares of stock by an inexperienced member of the public, who does not even own what he is selling, and has some largely emotional conviction that he will be able to buy them back at a much lower price. (It is not irrelevant to point out that when the 1962 article appeared the market had already experienced a decline of major size, and was now getting ready for an even greater upswing. It was about as poor a time as possible for selling short.) In a more general sense, the later-used
phrase “reckless investors” could be regarded as a laughable contradiction in terms—something like “spendthrift misers”—were this misuse of language not so mischievous. The newspaper employed the word “investor” in these instances because, in the easy language of Wall Street, everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin. Compare this with the attitude of the public toward common stocks in 1948, when over 90% of those queried expressed themselves as opposed to the purchase of common stocks.3 About half gave as their reason “not safe, a gamble,” and about half, the reason “not familiar with.”* It is indeed ironical Investment versus Speculation 19 * The survey Graham cites was conducted for the Fed by the University of Michigan and was published in the Federal Reserve Bulletin, July, 1948.
People were asked, “Suppose a man decides not to spend his money. He can either put it in a bank or in bonds or he can invest it.
What do you think would be the wisest thing for him to do with the money nowadays—put it in the bank, buy savings bonds with it, invest it in real estate, or buy common stock with it?” Only 4% thought common stock would offer a “satisfactory”
return; 26% considered it “not safe” or a “gamble.” From 1949 through
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