The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [27]
The outright ownership of real estate has long been considered as a sound long-term investment, carrying with it a goodly amount of protection against inflation. Unfortunately, real-estate values are also subject to wide fluctuations; serious errors can be made in location, price paid, etc.; there are pitfalls in salesmen’s wiles. Finally, diversification is not practical for the investor of moderate means, except by various types of participations with others and with the special hazards that attach to new flotations—not too different from common-stock ownership. This too is not our field. All we should say to the investor is, “Be sure it’s yours before you go into it.”
Conclusion
Naturally, we return to the policy recommended in our previous chapter. Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket—neither in the bond basket, despite the unprecedentedly high returns that bonds have recently offered; nor in the stock basket, despite the prospect of continuing inflation.
The more the investor depends on his portfolio and the income therefrom, the more necessary it is for him to guard against the unexpected and the disconcerting in this part of his life. It is axiomatic that the conservative investor should seek to minimize his risks. We think strongly that the risks involved in buying, say, a telephone-company bond at yields of nearly 7½% are much less than those involved in buying the DJIA at 900 (or any stock list equivalent thereto). But the possibility of large-scale inflation remains, and the investor must carry some insurance against it. There is no certainty that a stock component will insure adequately against such inflation, but it should carry more protection than the bond component.
This is what we said on the subject in our 1965 edition (p. 97), and we would write the same today:
It must be evident to the reader that we have no enthusiasm for common stocks at these levels (892 for the DJIA). For reasons already given we feel that the defensive investor cannot afford to be without an appreciable proportion of common stocks in his portfolio, even if we regard them as the lesser of two evils—the greater being the risks in an all-bond holding.
Commentary on Chapter 2
Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five-year-old can do it.
—Henny Youngman
Inflation? Who cares about that?
After all, the annual rise in the cost of goods and services averaged less than 2.2% between 1997 and 2002—and economists believe that even that rock-bottom rate may be overstated.1 (Think, for instance, of how the prices of computers and home electronics have plummeted—and how the quality of many goods has risen, meaning that consumers are getting better value for their money.) In recent years, the true rate of inflation in the United States has probably run around 1% annually—an increase so infinitesimal that many pundits have proclaimed that “inflation is dead.”2
The Money Illusion
There’s another reason investors overlook the importance of inflation: what psychologists call the “money illusion.” If you receive a 2% raise in a year when inflation runs at 4%, you will almost certainly feel better than you will if you take a 2% pay cut during a year when inflation is zero. Yet both changes in your salary leave you in a virtually identical position—2% worse off after inflation. So long as the nominal (or absolute) change is positive, we view it as a good thing—even if the real (or after-inflation) result is negative. And any change in your own salary is more vivid and specific than the generalized change of prices in the economy as a whole.3 Likewise, investors were delighted to earn 11% on bank certificates of deposit (CDs) in 1980 and are bitterly disappointed to be earning only around 2% in 2003—even though they were losing money after inflation back then