In Investing, Guard Against Recklessness, but Master Your Fear
For as long as there have been markets, investors’ minds have been battlegrounds for two warring ideas, much like the market itself forever swings between fear and greed. These ideas seize control in cycles, each dominating the landscape for a time before giving way to the other.
One philosophy argues that making money in the stock market is simple. When a bull market arrives, you just rush in, buy anything, and watch the profits roll in like you’re picking money up off the street.
The other view claims that making money in the market is impossibly difficult. It’s a soul-crushing endeavor where, after years of sleepless nights and exhausting effort, you find yourself in a winner-take-all arena. In the end, only the large institutions with overwhelming advantages in information, capital, or expertise can profit. The average investor is merely fodder, destined to be part of the classic Wall Street adage: “one gets rich, two break even, and seven lose money.”
Borrowing from political history, the first view is a form of reckless optimism, while the second is a kind of defeatist pessimism. Among market newcomers, this fearless optimism is common. But after being educated by a few bull and bear cycles, a different danger emerges for the “veteran” investors: a paralyzing pessimism. They become afraid of everything: afraid of losses, afraid of drawdowns, afraid of a rally they might miss, afraid of volatility, afraid of bad news, afraid of not doing enough research, afraid of some piece of information they overlooked, and even afraid of the fact that they might not be afraid enough.
Since most of you reading this have some investing experience, the primary obstacle to overcome is this defeatist mindset—the idea that “making money in stocks is too hard unless you have deep research skills, visionary strategic insight, a mastery of finance, and the unflappable calm of a stoic philosopher.” This belief is profoundly wrong. If left uncorrected, it will not only leave you in a constant state of anxiety but will also quietly steer your investment journey down the wrong path.
Major U.S. Market Drawdowns Since 1929
Severe market declines are rare but recurring, and markets eventually recover.
A Tale of Two Factories
Imagine a factory. The ambitious owner spent $10 million to get it up and running: securing permits, buying the land, constructing the building, installing the equipment, and hiring a workforce. Suddenly, disaster strikes, and for personal reasons, the owner is forced to sell the entire operation for just $5 million. If you buy it, are you guaranteed to make money?
Your first instinct might be to say, “Of course! I could flip it for an instant profit.”
Sorry, but that’s the wrong answer. You could still lose money. You might not find a buyer right away. Lacking operational expertise, you watch as the machinery rusts, workers leave, the roof begins to leak, and weeds overtake the property. Five years later, you finally manage to sell it for $6 million. At first glance, that’s a $1 million profit. But was it? That works out to a return of less than 4% per year.
This is where the concept of discounting comes in; money has time value. You could have put your capital in a risk-free 5-year U.S. Treasury bond yielding 4% and ended up with $6.08 million without any of the stress or effort. When you factor in the headaches and risk, your $6 million sale was actually a loss.
Now, let’s change the scenario. Imagine the same factory, built for $10 million and on sale for $5 million. But this time, you discover it also has $3 million in a corporate savings account, and $6 million in accounts receivable due by the end of the year from work completed for blue-chip customers like Apple and Microsoft. The factory’s only liability is a $1.5 million bank loan.
Now, if you buy this business for $5 million, will you lose money? This time, you can answer with confidence: no.
In this case, a profit is virtually guaranteed. You simply wait for the savings to mature and the receivables to be paid. That’s $9 million in cash. After paying off the $1.5 million loan, you’re left with $7.5 million in cash—a $2.5 million profit—plus a fully operational factory that cost $10 million to build.
Factory Investment Scenarios: Value of Discounting
This, in essence, is the investment system of Benjamin Graham. He searched for companies trading at a significant discount to their net working capital. Of course, the real world is messier. A company’s liquid assets are rarely as reliable as in our example, and as a minority shareholder, you can’t force management to liquidate assets and distribute the cash. Graham’s solution was to buy a diversified portfolio of dozens of these “cigar butt” stocks—companies discarded by others but with one last free puff of profit left in them. This diversification hedged against the risk that some of the companies had bad assets or uncollectible receivables. It’s not hard to understand why this method makes money.
The Logic of Market Madness
What is hard to understand is why anyone would sell a business for such a ridiculously low price. In the private market, an owner would have to be a fool to sell at such a valuation. But something funny happens when a company’s ownership is chopped into millions of tiny shares and traded on a stock exchange. To a huge number of market participants, a stock isn’t a piece of a business; it’s a gambling chip, a lottery ticket. When that stock is in a “downtrend,” their only priority is to cash out and preserve their stake for the next bet. They give this behavior a sophisticated-sounding name, like “following the trend” or “not fighting the Fed.” And just like that, absurdly cheap prices are born from collective panic.
Graham found countless opportunities like this during the Great Depression of the 1930s, some even more extreme than the example above. He and his followers simply picked up the “trash” that others had thrown away and waited for the panic to subside. When the stock prices recovered to reflect the companies’ underlying asset values, they sold. In Graham’s hands, “stock trading” was transformed from a game of guesswork and insider tips into a logical, calculable science. He deservedly became known as the father of security analysis.
Unfortunately, a crash on the scale of the Great Depression, which saw the U.S. market fall by 89%, is something an investor might see once in a lifetime. In the near-century since, only a few other panics have come close in severity, such as the 1973-74 crash (-48%), the dot-com bust of 2000-2002 (-49% for the S&P 500), and the 2008 financial crisis (-57%). These events, while painful, are not ancient history. They are a recurring feature of markets.
So, what is an investor to do in the long stretches between these rare, deep-value opportunities? Through the work of Graham’s disciples, three main paths have emerged.
Path 1: The Modern Graham Approach
The first path is to follow Graham’s own advice for the “defensive” (i.e., everyday) investor by slightly relaxing his strictest criteria. In his 1949 masterpiece, The Intelligent Investor, Graham laid out four principles for the common investor:
- Diversification: 10–30 stocks
- Size & Stability: “Large, conservatively financed”
- Dividend Record: “Long, uninterrupted history”
- Valuation: P/E ≤ 20–25 (7-year avg)
Path 2: The Global Cigar Butt Hunter
The second path is for those who wish to stick to Graham’s original, strict “cigar butt” criteria. To find these rare gems, they expand their search across the globe, digging through unpopular and obscure markets. The classic example is Walter Schloss, who, by rigorously applying Graham’s methods, achieved a master-level annualized return of 20% over 47 years. Today, a group of investors follows in his footsteps, scouring U.S., European, and emerging markets. They use simple financial screens to find companies trading for less than their net assets, do a bit of digging, buy a basket of them, and wait for the value to be recognized.
Path 3: The Buffett Evolution—From Assets to Earnings Power
The third path was pioneered by Warren Buffett. Influenced by thinkers like Philip Fisher and Charlie Munger, Buffett evolved Graham’s core idea. He shifted the perspective from “a stock represents ownership of a company’s net assets” to “a stock represents a claim on a company’s future stream of distributable cash flow.” This was a monumental leap. It transformed the investor from a “vulture,” picking through corporate carcasses for liquidation value, into a “partner” in the long-term success of a business. It allowed Buffett to look forward, to invest in the perpetual growth of the economy and human ingenuity. To identify businesses with predictable and sustainable future cash flows, Buffett added the concepts of “moats” (durable competitive advantages) and “circle of competence” (investing only in what you understand). He began searching for wonderful companies that provide essential products or services that are difficult, if not impossible, for competitors to replicate.
Three Paths of Value Investing
The Path to Fearless Investing
Whichever of these three paths you choose, making money is not the impossibly difficult task the pessimists claim it is. Path 1 requires just a periodic, disciplined screening of valuation metrics. Path 2 is a matter of diligent work; if you turn over enough rocks, you will find hidden treasure. Path 3 can begin as simply as buying a broad-market index fund, like one that tracks the S&P 500. You only need to grasp one fundamental concept: The average earnings of the S&P 500 companies will, over the long term, grow faster than the U.S. economy (GDP), which in turn will grow faster than the return on cash (like savings accounts or bonds).
Power of Compounding: $100,000 Over 50 Years
Depending on your risk tolerance, you can invest a lump sum or use dollar-cost averaging to smooth out the ride. All of this requires just one crucial mind-shift: abandon the idea that stocks are speculative chips and embrace the conviction that if a business’s true earning power grows, its stock price must eventually follow. Ignore the dramatic run-ups in junk stocks. Let the market chatter fade into the background. Invest with capital you won’t need for at least three to five years, and be content to let the growth of the underlying businesses drive your returns.
Once you do this, the market is no longer something to be feared. You can throw away the defeatist pessimism and stop living in a state of constant anxiety. When you are anchored by the real-world earnings of the businesses you own, you can then treat the market’s manic swings as an opportunity, not a threat. When others panic, you can calmly buy their shares at a discount. When they get euphoric, you can sell to them at a premium. And if you miss these opportunities? It doesn’t matter. You still own great businesses. What is there to fear?
In early 2000, Apple Inc. was left for dead, with a market capitalization of around $5 billion. By early 2025, its market value had surged past $3 trillion, built upon annual net income approaching $100 billion. Over the years, it has returned hundreds of billions to shareholders via dividends and buybacks. There was never any force on earth that could have permanently held the market value of such a cash-generating machine at its year-2000 levels.
Apple Inc.: Market Cap and Net Income Growth (2000–2025)
As long as you don’t wildly overpay, if the companies you invest in can grow their profits at a high rate over the long term, your investment return will eventually mirror that growth. No one—not Wall Street analysts, not the Federal Reserve, not the President—can change that fundamental destiny. Once you truly understand this, the defeatist pessimism will vanish forever. You will stand taller, think clearer, and find yourself on the wide, open road to financial freedom. The rest is straightforward: find a great business, wait for a good price (courtesy of the market’s manic-depressive nature), buy with conviction, and get on with living a happy life.
Stay tuned
Relax to Rich — Calm, Thoughtful Investing