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When I Met the Legends of Investing – Part 2

“In the morning, if you see me smiling in my sleep, please do not wake me up!” I advised my wife before going to sleep.

“Why?” she asked.

“Because last time you woke me up just when I was starting to learn the art of investing straight from the legends who visited me in my dreams!

“This time, if you see me smiling and talking to myself in the morning, know that I am seeing a similar dream. So don’t wake me up!”

“You sound so funny so often!” she told me as I switched off the lights.

Anyways, I saw the second part of my dream, and here’s the transcript. (Read first part here)

Me: Warren, last time we met, I asked you about the relevance of investing in stocks and especially for the long term. You tried your best to get your point through, but I was still not convinced.

Over the weekend, I thought over our discussion and then talked to some friends who are already investing in stocks. They revealed they are making 20-30% returns every month by trading in stock derivatives. Now this has gotten me really interested.

You only told me about stocks and never about derivatives the last time we talked. Why?

Warren Buffett: Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system.

Right Charlie?

Charlie Munger: The world of derivatives is full of holes that very few people are really aware of. It’s like hydrogen and oxygen sitting on the corner waiting for a little flame.

Me: But haven’t the big investors made so much money from derivatives in the past?

Munger: I would economically restrain what investment banks and banks do. I would separate derivatives from the basic bridges of civilization. We don’t want civilization contaminated by extreme speculation.

Me: What if speculation can earn you so much money in quick time? Isn’t that an easy-to-win game?

Buffett: If you’re an investor, you’re looking on what the asset is going to do, if you’re a speculator, you’re commonly focusing on what the price of the object is going to do, and that’s not our game.

Me: Investor? Speculator? What’s the difference?

Buffett: You know, speculation is like pornography…the famous quote and all that. I look at it in terms of the intent of the person engaging in the transaction.

Speculation I would define as much more focused on the price action of the stock you buy. You are not looking to the asset itself. The real test of what you’re doing is whether you care whether markets are open. When I buy a stock, I don’t care whether they close the stock market tomorrow for a couple years. I’m looking to the business, Coca-Cola or whatever, to produce returns for me in the future from the business.

Me: Okay, and what is an investment then?

Buffett: An investment operation in my view is one where you look at the asset itself to determine your decision to lay out some money now to get some more money back later on. You don’t really care whether there’s a quote on it at all.

Benjamin Graham enters the room and everyone stands as a mark of respect.

Buffett: Hey, Ben, you came in just at the right time. We were discussing what separates investing from speculation. Can you add some light to the distinction?

Benjamin Graham: One of the disastrous consequences of the New Era madness in Wall Street has been the disappearance of the former clean-cut distinctions between investment and speculation in common stocks.

Old-time investment, with its emphasis on book value and the past record, was short-sighted and naive, but it possessed the supreme virtue of moderation. Present-day “investment,” as practiced by investment trusts and everyone else, is not much more than an undisciplined wagering upon the future and as such logically indistinguishable from speculation.

Me: So you are saying that everyone is speculator and no one’s an investor these days?

Graham: In the easy language of Wall Street, everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin.

Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions, as the consequence of the ingrained tendency of most people to speculate or gamble–i.e., to give way to hope, fear and greed.

Me: That’s human nature, isn’t it? But can’t such behaviour be corrected?

Graham: I arrive finally at a “law” about human nature that cannot be repealed and it is unlikely to be modified to any great extent. This law says that people without experience or superior abilities may make a lot of money fast in the stock market, but most cannot keep what they make, and most of them will end up as net losers.

Buffett: As someone said, “There is no such thing as a free lunch.”

Graham: The stock market has undoubtedly reached a stage where there are many people interested in free lunches.

Let me conclude with one of my favorite clichés – the French saying: “The more it changes the more it’s the same thing.” I have always thought this motto applied to the stock market better than anywhere else. Now the really important part of this proverb is the phrase “the more it changes.”

The economic world has changed radically and it will change even more. Most people think now that the essential nature of the stock market has been undergoing a corresponding change.

But if my cliché is sound – and a cliché’s only excuse, I suppose, is that it is sound –then the stock market will continue to be essentially what it always was in the past – a place where a big bull market is inevitably followed by a big bear market.

Me: So there’s no hope, right? That’s what I have been saying all this while.

Graham: But I never said there’s no hope!

Me: So Mr. Graham, do you recommend that a man of moderate means include some stocks when he invests his savings for the long term?

Graham: My answer would be definitely “yes”, under normal conditions.

Me: Why?

Graham: Because common stocks have the advantage, in the first instance, of representing sound, growing investments, with a higher return than you would get on bonds, and secondly, because they do carry some measure of protection against inflation.

Me: Okay, but can anyone who buys stocks succeed as an investor?

Graham: There are two requirements for success as an investor. One, you have to think correctly; and secondly, you have to think independently.

Me: Is that your only advice for investing success?

Graham: My advice would be to study the past record of the stock market, study your own capabilities, and find out whether you can identify an approach to investment you feel would be satisfactory in your own case.

And if you have done that, pursue that without any reference to what other people do or think or say. Stick to your own methods. That’s what we did with our own business. We never followed the crowd, and I think that’s favorable for you as an investor.

Buffett: You may also want to tell him your three rules for investors.

Graham: Oh yes! Let me suggest three rules for individual investor regarding investment policy:

  1. The individual investor should act consistently as an investor and not as a speculator. This means, in sum, that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase – in other words, that he has a margin of safety, in value terms, to protect his commitment.
  2. The investor should have a definite selling policy for all his common stock commitments, corresponding to his buying techniques.
  3. Finally, the investor should always have a minimum percentage of his total portfolio in common stocks and a minimum percentage in bond equivalents. I recommend at least 25 per cent of the total at all times in each category. A good case can be made for a consistent 50-50 division here, with adjustments for changes in the market level. This means the investor would switch some of his stocks into bonds on significant rises of the market level, and vice-versa when the market declines.

Me: Great! Now as far as analysing common stocks is concerned, a friend referred me to your Security Analysis, which he called the Bible of investing. Is that where I should start?

Graham: They called it the “Bible of Graham and Dodd.” Yes, well now I have lost most of the interest I had in the details of security analysis which I devoted myself to so strenuously for many years.

I feel that they are relatively unimportant, which, in a sense, has put me opposed to developments in the whole profession.

I think we can do it successfully with a few techniques and simple principles. The main point is to have the right general principles and the character to stick to them.

Read The Intelligent Investor – which I feel would be more useful than Security Analysis of the two books.

Me: I am very enthusiastic to try my hands at stocks now, after talking to you Mr. Graham!

Graham: While enthusiasm may be necessary for great accomplishments elsewhere, on the stock market it almost invariably leads to disaster.

“Wake up Papa! It’s already 8 O’clock!” I heard as I rubbed my eyes. This time it was my daughter who woke me up.

“Grrr…I must sleep in an isolated room the next time,” I muttered under my breath as she handed me my bicycle keys.

“All sleep and no play makes Papa a dull boy!” she told me.

I got up, determined to carry on with my dream sooner than later. This was, after all, getting very interesting.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. Hi ..Interesting stuff..!..However traders do make money..And long term investors may not in the long run..Like HUL stayed horizontal for a decade .Its about a combination of technicals and fundamentals,

    • Hi Swati, thanks for your comment! I believe it’s not just about making money but also keeping it. HUL has been an exception among so many long term value creators. Regards.

      • Respected Vishal,

        You are doing great job in spreading the pearl of wisdom about financial planning and capital market. 🙂

        Sorry to contradict but HUL is not an exceptional.There are many many such stocks. Bhel, Infosys, HCL Tech, Wipro, Century Textiles, Bombay Dying, Most of the Reliance stock except few like RIL, Most of the Tata stocks except few like TCS/Beverage company, Most of the PSU companies including most of the PSU Banks, Most of the Metals/Commodity stocks, Most of the brokerage, Textiles, Suger, Cement, Shipping, Capital Goods, Media companies. List is too long that has performed very badly in last 6-12 years. I assume 6-7 years is also long term. NO ?

        Barring few sectors like FMCG/Consumer products/Personal Care, Banking/Finance and Pharma/Healthcare, Most of the sectors has under-performed in last 6-8 years of course if you Buy and Hold for very long term without timing the market. Gold, Real-estate, Debt fund all have delivered much better return in the same time-frame.

        For 20 years (1992 – 2012) the Sensex has returned a CAGR of only 7% whereas Nifty since inception (1994) has returned of only 7% which is lower than Bank FDs. Is this not long term? Gold/Real-Estate has moved more than 10-15 times in last 10-15 years. Also, Most of the stocks that has given excellent return in last many years where always expensive. Like HDFC, Titan, Page, Bata, Jubilent Foods, etc. and those that were so called value picks remained “value traps” for long long time like PSU Banks, Infy, Holding companies like Tata Investment and many from many sectors. Market always give more importance to those companies which maintain consistency in their earnings. Most of the cheap stocks remain cheap until of course you are lucky to find stocks like Wockhardt, TTK Prestige, HDFC Bank.

        In my view, It’s better to Buy 10 stocks which can grow 20%-30% CAGR for next 5 years rather buy 10 value picks which might or might not perform. Even 1-2 become 5-10 times Multibagger, Overall return would be less than growth picks over period of 10 years. Yes, it’s little risky in starting (1-2 years) but after 2-3 years it become safe, solid and good portfolio. When i bought stocks like Bata, Godrej Industries and HDFC Bank in 2010, it was expensive at that time. It’s expensive even today but stock price has appreciated between 80% and 300%. Good stocks always remain expensive until of course we are in bear market which comes once/twice in a decade.


        • Hi Amit,
          I would reluctantly agree with you. Though I’m an investor with value investing bent of mind, I can see what you are saying. It is not hard to visualize that a portfolio comprised of companies that are top 1st/2nd in their sector and spread across 10-15 companies stands an excellent chance of beating indices, FDs, and inflation over the long term. Current valuation may be high, but its high for a reason. And once in a while you do find rotten apples like Satyam or Suzlon, but that’s why you diversify and the expectation is that other stocks will more than make up for such duds over the long term.

  2. Sanjeev Bhatia says:

    Great Second dream.

    I must say you have a very understanding wife. Had I said the same thing to my wife, she would have said : With whom you were with in your dream that you were smiling so much? 😉 with the universal follow up quote of “tum sab mard aik jaise hi hote ho” … :P.

    Coming back to post, I must say, at the danger of almost causing a sacrilege, that there is no ONE way of earning from stock market. So it is with derivatives or trading. It can be argued, and quite convincingly at that, that there is more money to be made trading DLF rather than buying and holding, say, HUL.

    The point is whether you KNOW, and I mean REALLY know, what you are doing, with proper risk management in place.

    Buffet himself writes put options, which he has even mentioned in some of his letters to shareholders. (for eg. he earned a profit of 222 million and use of 647 million USD interest free for three years, and that is just from unwinding of eight positions out of 251 contracts, as mentioned in his 2010 letter). Similarly, there have been many a successful traders. Even a same person can be part trader and part Investor, like say RJ. One can easily have both trading portfolio and investment portfolio.

    Of course, one must be very, very clear in his/her mind what he/she intends to do:- Invest or speculate. and do things accordingly, not becoming Investor by force due to a speculative trade gone wrong as is mostly the case. :D.

    And you are bang on in saying that it is equity which can provide a cushion against inflation due to its capabilities of giving inflation adjusted real rate of return.

    A nice, thought provoking post. Looking forward to continuation of the same..

    • Agree. Surely there is no one way, which all masters also acknowledge. These are all check posts and wisdom rules which must be applied irrespective of the method provided, as you say, you know.
      In Alice in Wonderland, Alice having reached a cross roads asks the Cheshire Cat “Which way do I go ?” The Cheshire cat replies “Depends on where you want to reach !”

    • Indeed Sanjeev, derivatives can be a profit maker for those who know the in-and-out of the products and have the time to track them. But then you also need to take into account the “return per unit of stress”.

      As Prof. Bakshi wrote in an amazing post – “Once you start incorporating return per unit of stress in your investment thinking, the trade-offs become obvious. You would start settling for investment situations which offer a satisfactory return per unit of risk and stress over those which offer high returns per unit of financial risk but low returns per unit of stress. You will slow down and start appreciating the slow process of long-term, stress-free compounding as opposed to nerve-wracking, adrenalin laden high frequency operations in the stock market.”

      The question is – can you adapt to the high stress that derivatives bring with them. If not, better stay far away instead of trying to make a quick buck “just this time”.

      As far as Buffett is concerned, we need to understand that despite being known as a “value investor”, he is a hedge fund manager at heart and actions. So, like we must not copy his investment rule word by word, we must not trade in derivatives just because he does it successfully.

      Finally, you are right in saying – Of course, one must be very, very clear in his/her mind what he/she intends to do:- Invest or speculate. and do things accordingly, not becoming Investor by force due to a speculative trade gone wrong as is mostly the case. Regards.

      • Manish Sharma says:

        Very true, Vishal! Return per unit of stress is an important concept not only in investment but in life. And, both investing and trading have their own pros and cons. I have known people who have been actively trading for past many years because their mental make-up is suited to it. Similarly, passive long term investing has its own benefits and various people with typical behavioural characteristics and traits can be benefited better with this approach. It is up to the reader, and individual investor to decide which approach suits him/her the best. Apart from stress, frenetic trading activity, brokerage cost, constant monitoring of tape, and other minor transaction costs need to be taken into account before one jumps in the bandwagon. Also, i feel HUL has become a sort of punching bag on blogosphere and everyone is trying to use by quoting it as an example to pick holes in the long term investment philosophy. Investing is a loser’s game and one should always strive to minimise losess, forget about the past decade, without the benefit of hindsight the chances of losing money while holding HUL may still be less than the chances of trading DLF. Eventually derivatives are weapon of mass destruction indeed, and one should be careful as the chances of black swan event are higher than normal. I would any day go by Jim Rogers quote that more than return on my money, i am more interested in return of my money.

        • Sanjeev Bhatia says:

          Hi Manish,

          I have simply highlighted the point that there is no single way of getting returns from market, nothing less and nothing more. The example of DLF and HUL was just to present a contrary perspective. As value investors, we may scoff at the “OTHER” methods of earning, but we must also understand and appreciate that as we have right to our view, so has the other person right to their views. We may ridicule Technical Analysis, for ex, but there are people who trade using those and have been earning money. If they enjoy the returns per unit stress, so be it. That is THEIR problem… LOL.

          As far as DLF/HUL are concerned, there are many more examples. You can replace them with many other scrips. The opportunity cost of holding a dud share that does not go anywhere in say 3/5yrs will also reflect on your returns as does the brokerage/commission if you churn frequently. This I am saying despite being a strong advocate of Buy and Hold, having scrips/mf in my portfolio going back more than 13-15 years. ;). I simply quoted these because both are highly liquid scrips and darlings of traders as well as investors.

          If just Return of the Money is prime objective, than why bother with equity market as such? Why not go in simply for FDs etc where stress is even less/nonexistant…LOL. And no need to read books, analyse companies, read annual reports etc etc, a truly mind boggling task, and despite all this, you still don’t know whether market will prove you wrong or right, you will have a horse in your portfolio or an ass…:P. Just imagine, lots of time to enjoy with your family, no ever growing pending readings list, no dreams about RoE, RoIC, debt/equity ratios….. and have dreams about Sunny Leone Perhaps… 😉 (or whatever your current poison is… LOL)

          The truth is, we HAVE to assume certain risks, have some stress in the HOPE of getting inflation beating returns. There is simply no other way, unfortunately.

          It just depends upon the person concern-eds temperament. If he is more tuned to trading, so be it. If he is more into passive investing or buy and hold, no harm. And if he can compartmentalize and can both trade and invest, so much the better. It is almost like debate on being vegetarian or non-vegetarian. As much as I like non-vegetarian stuff, I can’t, and shouldn’t, ridicule or be judgmental about any vegetarian for his choice.


          • Manish Sharma says:

            I would just like to say few points:

            I have never ridiculed technical analysis in my reply.

            Can anyone say for sure where the stock will go 5 years from now? One just needs to take an educated guess based on the quality of balance sheet, longevity of business and looking at decent valuation. that’s it…compared to active trading there is still less risk and stress involved in it…

            You took the example of DLF, not me. I would still maintain trading DLF counter is still a risky business, i have personally seen people losing money on it.

            Yes, anyone who can’t take any stress they can still park their funds in FDs etc..

            And, finally there was no need to go personal during your reply. Those personal innuendos were not needed. You can say whatever you want to say about yourself, but you don’t have any right to mock was in very poor taste…

            My response was more aimed at having some decent discussion over a serious matter. I wonder if this is a rediff forum or what. If this is the level of debate and discussion over here then Vishal, it is better to have some sort of filter over the responses. Or else, one should remain silent…

            • Sanjeev Bhatia says:

              Oh My, Dear Manish, you have taken me all wrong.

              I never said, YOU ridiculed technical analysis. I just gave an example. Ditto for trading/investing part. That was exactly my point, that despite your better efforts you don’t know what market has in store for you. Both you and me know that there is more stress and costs associated with active trading, what I am just trying to convey is that there are people who ENJOY these and their own sweet will, that’s all. Maybe their temperament is suited to these kind of activities.

              DLF, agreed is risky. But again that is for us. For a trader, who likes volatility (otherwise there is not much premium for call/put options), this might be a great counter to trade in. Again, just a different perspective. Since stock trading is zero sum game, if some have lost, some have gained too, isn’t it?

              I really fail to see where I have gone personal or mocked you. You very well know I can’t even dream of doing so. If you are referring to the part about reading etc, brother, we both are in the same boat. I am also involved in reading a lot, trying to grasp the nuances (in which YOU, of all the people, have been a great help) and trying to be a better investor. I was just trying to bring home the point that there is no shortcut, that we all are trying to evolve here and was not meant just for you. Whatever has been said can be put for me too. If I get a 13-14% annualized GUARANTEED return somewhere, why would I spend my days and nights reading and doing all other exercises to get the same return? I am really sorry if you took it as “Mocking” you. Believe me, that was never the intention. If it has come out that way, I apologize sincerely.

              If you are referring to the Sunny Leone part, that was added just to make light of the situation. I never knew one could take it so seriously.

              Once again, I apologize if your feelings have been hurt in any way despite the fact that I NEVER EVER had intentions of doing so.


              • Manish Sharma says:

                Yes sir, the Sunny Leone reference was absolutely juvenile. This is after all a public forum with different demographic profiles and we must remember this while doing the debates and discussions.

                • Sanjeev Bhatia says:

                  Even Warren Buffet commented somewhere : “some men read Playboy, I read Annual Reports”.

                  Is this, too, juvenile?

  3. This is good, easy to understand stuff (obviously difficult to follow) and put out so lucidly in the form of a conversation. Thank you.

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