I just started to read "The Intelligent Investor" by Benjamin Graham and right away I was struck by the essence of the problem he was trying to solve, in this pre-Markowitz book. His rather practical solution to the problem of volatility of (downside) returns is to burn in the margin of safety, that is to say, to seek out value. What you're doing there is in essence finding companies where book value is larger (by some margin) than the market price, then hoping this is enough to minimise downside variance. Secondly, he carves away 'speculator' from his interest, leaving only the investor, who in fact also attacks volatility by virtue of being a long term investor.
Thirdly, he seems to weigh the phenomenon of momentum trading poorly. He sees no value whatsoever in buying when the stock price is going up, and selling when that price is going down. In fact, this, to him, is the essence of the problem that speculators have. They expose themselves to too much trading and too much short-termism. But subsequent work by factor researchers confirms the hard-to-justify (on fundamental grounds) reality of a positive return to the momentum factor.
He gives the credit to the idea of 'dollar cost averaging' to Raskob, head of DuPont who suggested in 1929 that regular monthly investments in the stock market would lead to long term success. What I didn't realise, and it only hit me now, is that, this too is a way of defeating the vol of vol. By investing over a period of time, you increase the probability of avoiding a large investment just before you get hit by a bout of very high (downside) volatility. Spreading it over time means you experience closer to the 'average' volatility of that market. Subsequent research shows that 'lump sum' investing is (on average) more rewarding than dollar cost averaging. This may be true on average but there is no guarantee that you won' the the investor who walks right into a large downturn the week after you invest your whole lump sum.
The published version of the book which I'm reading is the 2006 reprint, with commentary provided by Jason Zweig, a personal finance journalist, and I'm finding the commentary interesting and also dated.
Graham already knew and reported on the high likelihood that precious few investors beat market averages. He also has this strangely resonant view on trading, that enthusiasm usually leads to disaster, which I personally struggle against, but think is correct. I have met with and worked with many traders in my life and have also made my own investments and I can confirm that many traders, even regularly successful ones, have a rather unenthusiastic persona. Perhaps that after all is a necessary but not sufficient trait. I have, on the other hand, also met unenthusiastic and poor traders, so I'm not entirely sure.
Finally, in a way, part of Graham''s message here is to remain calm, to quell the emotional volatility which resides in some investors hearts. All in all, whilst volatility isn't really explicitly discussed, it is seen as an enemy, to be challenged, avoided, fought. If one is rich enough, one can afford to accept low return and experience the low volatility of sovereign bond returns, but for everyone else, we must dip our toes in volatility. The essence of the modern view on good investing is that one only gets paid for accepting volatility. This emphasis isn't quite the same as in Chapter 1 of this book.
