The second lesson? In a long, drawn-out bull market, it’s easy to become complacent. Which is exactly what happened to Graham.

He carried a 44% margin debt on his fund because all the previous times he bought cheaply, the market gave him a chance to sell for a profit. Year after year of doing the same thing worked … until it didn’t. Even Graham’s value strategy has limits (made worse by complacency and leverage).

The third lesson was harder. How does one recover, mentally and financially, from such a devastating loss?

Graham dug himself out financially and then some. By 1935, he and his investors had fully recovered from the losses (a feat in itself).

But mentally, it was another story. As rational as Graham was, the experience would completely redefine him. He became a much more conservative investor. And sometimes, as James Grant tells it, the experience seeped into his writing:

I’m going to close with, to me, what is the great irony of Graham’s career as an analyst and as a participant in the financial markets… So Mr. Market was not content to ruin everyone’s life between the years 1929 and ’32. He wanted another lesson in 1937 just to make sure that you knew he was serious. So in 1937, there was what they call — the Roosevelt people call — a recession. It sounded so much more palatable than depression. The stock market, again, took a pratfall, a huge — I forgot what the decline was — say 40 percent. By this time, I think Graham had had enough. He was a wonderful, indeed, a great human being in so many ways, but he was a mortal being and he had had it. He had had it. And you could see his weariness shine through in the 1940 edition a little bit. And let this too be a lesson to us…

So, he had been through the mill, had Graham, and he seemed to let it show in the words of advice that he proffered to the institutional investors of his time. There weren’t so many of them. The people who manage trust funds and banks and who managed endowments, there weren’t so many of these people. There were some. And in his closing paragraphs, he spoke to them, these professionals. What should they do? Well, they should buy bonds, he said, bonds that were yielding two and three percent — two and three percent! Stocks, some of the better-paying stocks were yielding six, seven, eight percent, and up. Still, he says that institutional investors ought to avoid the stock market if they possibly could and buy bonds. This was five years before the all-time bottom in yields, high in prices… And indeed, Benjamin Graham said, stand clear. This is after like 750 pages of the most exquisite analysis of the risks and rewards of equities. Stand clear of them if you can. So learn from Graham’s example, both of his rising above his times and at intervals of his all too human weakness in being and succumbing to them.

Walter Schloss tried to explain just how impactful the 1929 experience was on Graham and others at the time and why crushing losses are so hard for investors to get over:

But Graham was concerned with limiting his risk and he didn’t want to lose money. People don’t remember what happened before and how things were. And that’s one of the mistakes people make in investing as well… People forget what things were like during the 1930s. I think Graham — because he lived through that period — remembered it, was scared it would happen again, and did everything he could to avoid it.

But in the process of avoiding it, he missed a lot of opportunities. That’s one of the problems you always have — you don’t really lose, but you don’t really make, either. I believe you should remember what took place — even if you weren’t around at the time. One of the problems of a lot of the people who went through the Depression — Ben Graham, Jerry Newman, and others — is that they keep on thinking that things will always be like that.

Even Graham used to say — and quite correctly — that you can’t run your investments as if a repeat of 1932 is around the corner. We can have a recession and things can get bad. But you can’t plan on that happening. People who did, missed this tremendous market.

Some people can do it. Most people can’t and I don’t think they should try.

Despite all of it, the most surprising thing is that Graham never abandoned his underlying philosophy. After experiencing the worst four years ever, anyone not penniless, likely quit. But not Graham. I think Michael Batnick, in Big Mistakes, sums it up best:

After an 89% peak-to-trough decline in the Dow Jones Industrial Average, it was understandable why people would behave this way, and why a generation of investors would never return to the market. The fact that he remained steadfast in his conviction that security analysis was a worthwhile endeavor is nothing short of remarkable… Despite the hard times and enormous drawdown, Graham would continue to operate under the assumption that value investing is the most intelligent way to achieve superior results.

Source: James Grant: Graham and Dodd Breakfast Oct. 2008
Walter Schloss: Outstanding Investor Digest 1989
Big Mistakes: The Best Investors and Their Worst Investments

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