My Key Takeaways From Chapter 4 and Commentary 4 of the Intelligent Investor. Part 5/16. To Be Continued.

Chapter 4 General Portfolio Policy: The Defensive Investor

The Basic Problem of Bond-Stock Allocation

We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.

The Bond Component

The choice of issues in the bond component of the investor’s portfolio will turn about 2 main questions: Should he buy taxable or tax-free bonds, and should be buy shorter-or longer term maturities? The tax decision should be mainly a matter of arithmetic, turning on the difference in yields as compared with the investor’s tax bracket. The choice of longer versus shorter maturities involves quite a different question, viz: Does the investor want to assure himself against a decline in the price of his bonds, but at the cost of (1) a lower annual yield and (2) loss of the possibility of an appreciable gain in principal value? We think it best to discuss this question in Chapter 8, The Investor and Market Fluctuations.

List of a few major types of bonds that deserve investor consideration:

1. U.S. Savings Bonds, Series E and Series H
2. Other United States Bonds
3. State and Municipal Bonds
4. Corporation Bonds

Higher Yielding Bond Investments
Saving Deposits in Lieu of Bonds
Convertible Issues
Call Provisions
Straight-i.e., Nonconvertible-Preferred Stocks
Security Forms

Commentary on Chapter 4

“When you leave it to chance, then all of a sudden you don’t have any more luck.” – Basketball coach Pat Riley

There are 2 ways to be an intelligent investor:

• By continually researching, selecting, and monitoring a dynamic mix of stocks, bonds, or mutual funds;
• Or by creating a permanent portfolio that runs on autopilot and requires no further effort (but generates very little excitement).

Graham’s distinction between active and passive investors is another of his reminders that financial risks lies not only where most of us look for it-in the economy or in our investments-but also within ourselves.

A traditional rule of thumb was to subtract your age from 100 and invest that percentage of your assets in stocks, with the rest in bonds or cash.

The Ins and Outs of Income Investing

Taxable or tax-free? Unless you’re in the lowest tax bracket, you should buy only tax-free (municipal) bonds outside your retirement accounts. Otherwise too much of your bond income will end up in the hands of the IRS.

Short-term or long-term? Bonds and interest rates teeter on opposite ends of a seesaw: If interest rates rise, bond prices fall although a short-term bond falls far less than a long-term bond. On the other hand, if interest rates fall, bond prices rise-and a long-term bond will outperform shorter ones.

*Figure 4-1 The Wide World of Bonds

Cash Is Not Trash
Treasury Securities
Savings Bonds

Moving Beyond Uncle Sam
Mortgage Securities
Annuities
Preferred Stock
Common Stock