Investing lessons from Benjamin Graham

Chris Leithner

Leithner & Company Ltd

Benjamin Grossbaum entered this life in 1894 as a Briton; Benjamin Graham left it in 1977 as an American. He inherited Judaism but chose Stoicism. In his autobiography (Benjamin Graham: The Memoirs of the Dean of Wall Street, McGraw-Hill, 1996), he recalled that he “embraced stoicism as a gospel sent to him from heaven.” The main components of his “internal equipment” included “unruffled serenity.” Graham’s son said of his father: “Maybe people who go into investing are especially well-suited for it if they have that distance and detachment.”

Graham as a “Stoic Contrarian”

Graham didn’t propose that a stereotypically stoic – that is, unemotional – temperament is a necessary condition of success as an investor. He did, however, consciously imbibe classical Stoicism. Hence the investor should strive to be “inversely emotional” (the term is Jason Zweig’s rather than Graham’s; see “If You Think the Worst Is Over, Take Benjamin Graham’s Advice,” The Wall Street Journal, 26 May 2009). Neither as a friend nor as a parent, spouse, etc., can or should you stifle all of your emotions. But as an investor, you should reason – that is, neither enthuse nor despair. Through reason perhaps you can – and through emotion you certainly cannot – ascertain sensible prices of securities and levels of markets, and act accordingly when prices don’t reflect values.

The more you do so, the greater is the degree to which you’ll recognise as vices – and thereby discount – those passions that the crowd perversely regards as “good.” Moreover, you’ll acknowledge and cultivate as virtues those attitudes and behaviours that the crowd typically ignores (or regards as “bad”).

These passions (vices) include the meek acceptance of “expert” opinion, impulsive buying and selling, suspension of doubt and disbelief, unbridled optimism (during the boom) and unmitigated pessimism (during the bust), blindly following the herd rather than thinking and acting independently, etc. The virtues comprise bold independence of thought and action, doubt of authority and willingness to ignore – and, when necessary, defy – the herd.

The emotions and actions that the crowd mistakenly regards as desirable and profitable are usually self-destructive passions and vices; similarly, the mindset and conduct that the crowd dismisses as risky and mistaken today are actually likely to prove prudent and wise over the long term. In particular, it’s typically good news when the prices of stocks – including those you own – fall; and if their prices rise, it’s generally bad news.

 How did Graham justify this recasting of reactions to events? “Basically,” he said in an oft-quoted but seldom-appreciated passage of The Intelligent Investor,

Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

As a Stoic, Graham developed calm and composure regarding – but was nonetheless alert to the opportunities presented by – markets’ short-term ups and downs. A sudden and sharp decrease of prices may provide an occasion to purchase more stocks at cheaper prices. Under such circumstances, the odds rise that the value of what you receive exceeds the price that you pay. A substantial increase of prices, on the other hand, mitigates and perhaps precludes this opportunity – and thus increases the risk that the price you pay exceeds the value you receive. “If you are shopping for common stocks,” he therefore counselled, “choose them the way you would buy groceries, not the way you would buy perfume.”

From the 1930s to the 1970s, Graham steadfastly resisted the volatile and unpredictable mood swings of “Mr Market” – his metaphor for the attitudes and actions of passion-prone speculators who erroneously regard themselves as investors. The longer and further the prices of stocks and bonds rise, he observed, the more confident (and eventually euphoric) Mr Market tends to become. As a result, many investors succumb to vice: they become overconfident, bet heavily upon “market darling” stocks and “hot” sectors, and thereby speculate rather than invest. Conversely, the longer and further the prices of stocks fall, the more despondent (and eventually depressed) most market participants become. 

At both extremes they abandon reason, embrace passion – and thereby succumb to vice. Graham almost invariably regarded the crowd’s exuberance as an amber caution light (and sometimes as a flashing red danger signal); equally, he took heart from its dashed expectations and regarded speculators’ misery as investors’ opportunity. Hence his contrarian counsel: investors should zig when the crowd zags to an extreme, and vice versa.

Graham’s ability to recast his emotions and invert his reactions – that is, to become “inversely emotional” – helped him to discern when the crowd’s opinions and actions had become extreme. Late in 1971, for example, he urged caution – just before the worst bear market in decades. At its nadir, in mid-1974, he delivered a speech entitled “Renaissance of Value” (republished in Janet Lowe’s book The Rediscovered Benjamin Graham in 1999). In that address he foresaw a period of “many years” during which “stock prices may languish.” He then startled and even bewildered his listeners: if it occurred, this would be good rather than bad news. “The true investor,” he said, “would be pleased rather than discouraged at the prospect of investing his new savings on [the] very satisfactory terms [prevailing during a bear market].” Graham’s conclusion disconcerted his audience even further: investors worthy of the name are “enviably fortunate” to benefit from the “advantages” of a long bear market.

The investor, in short, must strive to ensure not just that his reason masters his emotions; he must also recast his reactions to become “inversely emotional.”

Ben Graham’s “Inverse Emotion” and Charlie Munger’s “Inversion”

Prominent and successful investors have often trod different paths yet arrived at a similar conclusion. For example, Charlie Munger, the Vice Chairman of Berkshire Hathaway, once quipped: “all I want to know is where I’m going to die, so I’ll never go there.” He recollects:

“There are all kinds of tricks that I just got into by accident in life. One is, I invert all the time. I was a weather forecaster when I was in the [military]. How did I handle my new assignment? ... I figured out the men that I was actually making weather forecasts for: real pilots. I asked, “How can I kill these pilots?” That's not the question that most people would ask, but I wanted to know what the easiest way to kill them would be, so I could avoid it. And so, I thought it through in reverse ... “There are only two ways I’m ever going to kill a pilot,” I said, “I’m going to get him into ice his plane can’t handle, and that will kill him. Or I’m going to get him someplace where he’s going to run out of [fuel] before he can land.” I just was fanatic about avoiding those two hazards.

Munger has acknowledged that the Prussian mathematician, Carl Gustav Jacob Jacobi (1804-1851), often solved difficult problems by following a simple contrarian strategy: “man muβ immer umkehren” (loosely translated, “invert, always invert.”) According to Munger, Jacobi “knew that it is in the nature of things that many hard problems are best solved when they are addressed backward.” Jacobi applied the principle to mathematics; Munger extended it to investing. It’s not enough to think about difficult problems one way: you must consider them “forward” and “backward.” Inversion often prompts you to uncover hidden aspects about the problem you are trying to solve. “Indeed,” concludes Munger, “many problems can’t be solved forward.”

Emulating Stoic Sages – and Ben Graham

Over the decades, Graham successfully practiced what he preached. But can the average investor become sufficiently Stoic to master Mr Market’s erratic mood swings? In some contexts, Graham wasn’t sure; in others, he stated forthrightly that he didn’t think so. One example summarises his view. When markets are ebullient, commentators often assert that “buy and hold is dead.” In particular, they claim that dollar-cost averaging (the practice of investing equal amounts at regular intervals) is foolish. Asked in 1962 if it could ensure long-term investment success, Graham wrote: “such a policy will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously and courageously under all intervening conditions.” However, the practitioner must “be a different sort of person from the rest of us … not subject to the alternations of exhilaration and deep gloom that have accompanied the gyrations of the stock market for generations past.” He who dollar-cost averages must be (perhaps unconsciously) Stoic. But can he? “This,” Graham concluded, “I greatly doubt.”

We shouldn’t interpret this conclusion overly pessimistically. It doesn’t mean that nobody can resist the crowd’s passions. If anything, Graham is optimistic: some people can. Even better, and as Warren Buffett stressed in his Foreword to The Intelligent Investor (which I quoted in Part I) the adoption of Graham’s philosophy, temperament and operations doesn’t require an advanced degree or high IQ.

Only some people can adopt Graham’s mindset and methods because just a few can be bothered to try; but if you put your mind to it, Graham implies, you’ll probably invest more successfully than you would otherwise.

Let’s recapitulate. To become an intelligent investor, you must cultivate what Ben Graham called “firmness of character.” By this phrase he means the Stoic fortitude and self-control that’s necessary to defy Mr Market when his moods become extreme. When stocks as a whole are dangerously overpriced – as I believe they are now – you must ignore the stampeding herd’s exuberance and either buy very selectively, sit tight or predispose to sell; and when they become unreasonably cheap, you must ignore others’ pessimism and buy. Just as Stoics embraced reason to overcome passion, Graham emphasised the ability, through dispassionate analysis, cautiously to estimate the value of individual stocks and overall markets.

By Inverting, Graham’s Acolytes Become “Stoic Optimists”

Thousands of years ago, Stoics recognised that few people could become sages; during the second half of the twentieth century, Ben Graham was unenthusiastic regarding everyman’s ability to master his passions and control vices. Should we therefore conclude that he was a pessimist with respect to the individual’s ability to manage his financial affairs? I don’t think so:

 Stoics denied that everybody could become a sage; equally clearly, they readily affirmed that anybody – if she puts her mind to it – can become more virtuous. Similarly, although Graham in effect denied that anybody could invest as well as he did (or his most famous and successful acolyte, Warren Buffett, has), he acknowledged that anybody – if he’s willing to put his shoulder to the wheel – can invest more successfully.

This “stoic optimism” has another facet. In “Can the Dow Go Lower? I Hope So” (The Wall Street Journal, 20 November 2008) Jason Zweig described it:

 Let’s get this straight, folks. I’m not an optimist or a bull, at least not the way most investors usually use those terms. I would not be a bit surprised if the stock market fell another 20% or so from here. But stocks are already on sale – and further markdowns are good news, not bad, for anyone who is not retired or about to be. Since most of us have many years of saving and investing ahead of us, it is in our best interests for the fire sale to last longer and for the discounts to get deeper. As risky assets keep getting cheaper, we get to buy them at prices low enough to take most of the risk out of the equation [italics added].

Buffett has expressed similar sentiments. In Berkshire Hathaway’s Annual Report (1997), he described this inverted form of optimism:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

Zweig elaborated:

 If the history of the financial markets and the psychology of investing have anything to teach us, it is that present emotion and future returns are inversely correlated. Today’s feelings of pain and fear are the building blocks for tomorrow’s wealth. Eras of good feeling are terrible times to buy stocks. The corollary is that perceived risk and actual risk tend to be polar opposites.


“The overwhelming majority of people,” Seth Klarman has observed, “are comfortable with consensus, but successful investors tend to have a contrarian bent.” What's more,

Successful investors like stocks better when they’re going down … In the stock market, people panic when stocks are going down, so they like them less when they should like them more. When prices go down, you shouldn’t panic, but it’s hard to control your emotions when you’re overextended, when you see your net worth drop in half and you worry that you won’t have enough money to pay for your kids’ college.”
Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own [shares of X Ltd] and the stock price goes down by half. Do you like it better? … Do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.

Investing isn’t, as Zweig astutely wrote in one of his Commentaries in The Intelligent Investor, “about beating others at their game. It’s about controlling yourself at your game.” Mastering yourself, in turn, is a matter of character rather than cleverness. Hence “a disciplined stoicism, or some approximation of it, is the most effective psychological posture as an investor” (see Martin Conrad, “The Money Paradox,” Barron’s, 31 December 2011). Stoicism is cognitively easy to understand but psychologically difficult to practice. You must prepare for what the crowd mistakenly dreads (downdraughts and bear markets) and misguidedly celebrates (upswings and bull markets); then, whatever happens, accept it and maintain an unperturbed attitude.

 Whether or not you approach investment Stoically, your results as an investor stem primarily from your principles and processes and only secondarily from your intelligence and formal education. Investors worthy of the name, in other words, don’t “target returns” – instead, they pursue certain virtues. In particular, they seek true assumptions, valid logic and reliable evidence – and the ability to assess them dispassionately. They also know that actions stemming from these virtues will, over time, tend to beget desired results – namely fewer vices.

Thousands of years ago, Stoics showed that if you adopt a sound set of philosophical and spiritual principles to guide your actions, decision-making becomes relatively straightforward and calm (but hardly error-free!). But if you possess neither a philosophy of investment nor a broader (and congruent) system of ethics, then emotion rather than reason will dictate your thoughts – and your actions will probably alter in response to each change of your mood. Ultimately, be it in investing or life more generally, we all pursue what (mistakenly or otherwise) we regard as valuable. Only some, however, do so consciously, and few have carefully considered what we really seek.

This is the abridged second part (the attached pdf provides the full version) of a two-part series. Click FOLLOW on my profile (if you haven’t already) for notification when my next article appears. 

This blog contains general information and does not take into account your personal objectives, financial situation, needs, etc. Past performance is not an indication of future performance. In other words, Chris Leithner (Managing Director of Leithner & Company Pty Ltd, AFSL 259094, who presents his analyses sincerely and on an “as is” basis) probably doesn’t know you from Adam. Moreover, and whether you know it and like it or not, you’re an adult. So if you rely upon Chris’ analyses, then that’s your choice. And if you then lose or fail to make money, then that’s your choice’s consequence. So don’t complain (least of all to him). If you want somebody to blame, look in the mirror.

Chris Leithner
Managing Director
Leithner & Company Ltd

After concluding an academic career, Chris founded Leithner & Co. in 1999. He is also the author of The Bourgeois Manifesto: The Robinson Crusoe Ethic versus the Distemper of Our Times (2017); The Evil Princes of Martin Place: The Reserve Bank of...

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