Chapter 4: General Portfolio Policy – The Defensive Investor
In chapter 4 of the intelligent investor, the author has put forward a rough picture of a “General Portfolio”. This portfolio is for investors who practically has no in depth knowledge of the stock markets.
The defensive investor is regarded as a type of investor who does not actively participate in the stock markets study. He does not have a high risk appetite and is content with nominal returns and low risk.
Majority of people fall under the category of the defensive investor. These are working class people, who want to stay invested in the equities, but do not have time to track the day to day performance of the market. Thus, developed an idea of a general portfolio.
Defensive Investor vs Enterprising Investor
The author has put forward the following question – “What kind of an investor do you want to be”
- An investor who will actively research the market and find best opportunities to enter and exit an investment; or
- An investor who wants to invest the money and let it run on auto pilot
The author calls the first type of investor as an Enterprising Investor and the later as a Defensive Investor.
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The Percentage of Bond – Stock allocation
As per the fundamental guiding rule of investment, an investor should never have less than 25% or more than 75% of their portfolio in stocks. The vice versa in bonds also stands true.
The chapter also examines the idea of asset allocation. Thus, recommending that investors choose the right ratio of equities to bonds. This is based on investor’s time horizon, risk tolerance, and financial objectives.
Bonds are often thought to be less volatile and provide a more predictable income stream.
Therefore, Graham encourages defensive investors to favour a bigger allocation to the Bonds. He offers recommendations for allocating resources properly, taking age, income security, and personal situations into account.
Also Read: How To Achieve Optimal Asset Allocation
Considering a 50 – 50 : Bond – Stock allocation
A 50 – 50 : Bond – Stock allocation is considered to be ideal for the defensive investor. This means, the investor needs to maintain 50% of the portfolio into Bond Investment and the rest 50% into stocks.
In a case when, the stock out performs and the percentage holding of stock in the portfolio increases, the defensive investor needs to now sell his assets in stock and invest the gains from the stocks into the bonds to maintain the 50 – 50 ratio.
The Defensive Investor and Bond Investment
The book has majorly focused on two factors while selecting the right bond for defensive investor:
- What is your income tax slab
- How long you want to stay invested
- If the investors that fall under a higher tax slab, they need to allocate the assets in tax free Government bonds.
- If the investor want to invest in bonds for a short duration, the investor needs to select high grade bonds, that are liquid and backed by Government Trusts.
The Defensive Investor and Saving Deposits
The author believes that, it is ideal for a defensive investor to invest their money in saving deposits for a short duration.
The advantage of investing in saving deposits for short term, is that they are not directly impacted by the outcome of the stock markets.
The only demerits being that the saving deposits will provide a lower rate of return to the defensive investor.
Thus, the investor needs to make informed decision to transfer the funds from saving deposits to actual investments based on investors needs and risk appetite.
The Defensive Investor and Preferred Stocks
Preferred stocks are a type of equity investment instruments that combines features of Bonds and Equities.
Similar to bonds, preferred stocks pay out cash dividends, frequently at a greater yield than bonds. While, they carrying less risk than regular stocks and pay out higher dividend returns than bonds.
Preferred stocks are like holding an equity of the company, but the returns are more like payouts bonds in the form of fixed payments.
The author believes that, the defensive investor with a higher risk appetite needs to allocate some of their funds into preferred stocks, before directly holding equity.
Chapter 4 of the intelligent investor should be used as a guide, which offers information and details on stock selection, asset allocation, and portfolio design for defensive investors.
The author has put forth the ideas are intended to aid investors in navigating the market with an emphasis on risk management and the preservation of long-term wealth.