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Graham's Defensive Investor Selection Criteria


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Over very long periods of time market-cap weighted indexing has been a winning strategy. But it does historically seemed to have an unfortunate feast or famine dynamic which creates a sequence of return risk for people hoping to generate a passive income from their stocks.


Historically lost decades were often rescued by global diversification (but now markets are a lot more closely correlated) and the income available from dividends and interest on a balanced portfolio (but now the real income from a balanced portfolio is probably sub zero so good luck paying the bills out of that). And of course index funds by their mechanism tend to concentrate in the kind of stocks that have worked well in the recent past which dilutes some of the risk control diversification should provide.


So I have been looking into other alternatives suitable for a DIY investor.


I've been reading quite a bit of Graham and quite like his ideas re the kind of portfolio suitable for defensive investors. The basic idea is to emphasize quality i.e. industry leaders with long consistent track records of profits and dividends and modest debt but impose some limits in terms of the price you are prepared to pay (e.g. insisting on an average earnings yield around 1/3 higher than the AAA bond yield to build in a margin of safety). So you'd exclude glamour stocks and deep cyclicals.  But aside from those guidelines you'd emphasize diversification over selection.


My guess is with this kind of portfolio you might have enjoyed a smoother ride than an index fund holder especially during prolonged bear markets and more consistent returns over long stretches of time which might have made it easier to draw an income out of a combination of dividends and stock sales.


Main issue I can see with it in a modern economy dominated by services and technology companies there is a winner-takes-most dynamic whereby the benefits of economic growth are distributed unequally with winners and losers so you cannot really count on reinvested earnings to build up values in the same way as they have historically and with the tendency now towards buybacks rather than dividend payouts you aren't benefiting from much of a current income either. But of course there have been waves of new technology and disruption in the past and growth stocks have still broadly underperformed as a class.


Any thoughts?

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I have owned a blue chip growth fund and SPY. over last 20 years, the blue chip growth has outperformed SPY 2:1. and yet I have consistently held way more SPY. I believe the "winner-takes-most dynamic" that you refer to benefits the greater concentration of winners that are represented in a well run blue chip growth fund. yet SPY diversification has a way of soothing the worried mind

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