The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.
This is an important chapter because it affects such a large aspect of most investors’ decision making. Graham (correctly, in my view) points out that the vast majority of people depend on the opinions of others in formulating decisions about their portfolio. While it is reasonable to expect that professionals will help steer you away from making mistakes and hopefully help you earn a respectable return (though both of these are far from certain), the problem is that most investors believe they will get an above-average return in this manner. Graham says this is pure ballyhoo. The only manner in which an investor can achieve a consistent, above-average return on the advice of others is when the advice of others leads to a greater understanding of the market which makes the investor more competent in his own independent judgments and analysis. This allows him to become an enterprising investor, which should lead to greater returns than a purely defensive investor.
Graham looks at four different common providers of investment advice and discusses their proper role:
Investment Advisers at Banks
Proper Role: Shield clients from costly mistakes, help conserve principal value and produce a conservative return.
Financial Services Firms (Moody’s, Standard & Poor’s)
Proper Role: Provide interpretations and forecasts of business conditions, and rate the stability of companies. Generally, they should be used to provide information about firms, rather than investment decisions.
Graham cautions that Wall Street thrives on speculation and as such it often leads customers into the wrong investments. These are businesses that depend on commissions so they focus on day-to-day trading.
Proper Role: Avoid being influenced by speculative recommendations, and instead rely on these for analysis of individual securities and industries.
Graham cautions AGAINST the common behaviour of asking for investment advice from relatives or friends. Everyone thinks that the person they are asking has superior knowledge or experience, but generally this is not the case. We should heed Graham’s advice: “Most bad advice is given free.”
The defensive investor will likely not be equipped to judge the advice they receive, and instead should be explicit in stating the kind of securities they want to buy (following the advice of earlier chapters). Any reputable adviser will make suitable recommendations.
The enterprising investor will work in partnership with his advisers, demanding the reasoning behind their recommendations and will pass his own judgment upon them.