Principle No. 3: Know what kind of investor you are

Graham advised investors to know themselves. To illustrate, he made clear distinctions among various groups operating in the stock market.

Graham referred to "enterprising investors" and "defensive investors." Those in the first group make a serious commitment in time and energy to become good investors and equate the quality and amount of hands-on research with the expected return. If this isn't your cup of tea, then be content to get passive (possibly lower) returns but with much less time and work.

Graham turned the notion of "risk equals return" on its head. For him, the more work you put into your investments, the higher your return should be.

If you have neither the time nor the inclination to do quality research on your investments, then investing in an index is a good alternative. Graham said that the defensive investor could get an average return by simply buying the 30 stocks of the of the of the Dow Jones Industrial Average ($INDU) in equal amounts.

Both Graham and Buffett said that getting even an average return -- for example, equaling the return of the Standard & Poor's 500 Index ($INX) -- is more of an accomplishment than it might seem. The fallacy that many people buy into, according to Graham, is that if it's so easy to get an average return with little or no work (through indexing), then just a little more work should yield a slightly higher return. The reality is that most people who try this end up doing much worse than average.

In modern terms, defensive investors would own index funds of both stocks and bonds. In essence, they own the entire market, benefiting from the areas that perform the best without trying to pick those areas ahead of time.

In doing so, an investor is virtually guaranteed the market's return and avoids doing worse than average by just letting the stock market's overall results dictate long-term returns. According to Graham, beating the market is much easier said than done.

Not everyone in the stock market is an investor. Graham believed that it was critical for people to determine whether they were investors or speculators. The difference is simple: An investor looks at a stock as part of a business and stockholders as the owners of the business, while the speculator views stocks as expensive pieces of paper that hold no intrinsic value. For the speculator, value is determined solely by what someone will pay for the asset.

To paraphrase Graham, there is intelligent speculating as well as intelligent investing -- just be sure you understand which you are good at.

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