 Good day fellow investors. We continue with our review of Benjamin Graham's The Intelligent Investor and today we'll discuss chapter 4 which discusses the allocation between stocks and bonds. It might sound crazy in this environment that we'll be discussing bonds as who touches bonds now but portfolio allocation between stocks and bonds or cash is crucial for long term successful investing. So stick with me but before that I'm really curious to hear in the comments how much bonds or cash or any similar investment savings do you own now. I bet it is a little bit but nevertheless it is a key component of long term investing and we'll discuss that and see what Graham had to say about that in 1972 which is a year that is similar to this year as stocks were relatively high and a big drop happened in 1974 and it took 10 years for stocks to regain that territory. Let's start. The chapter starts with Graham's view on risk and he says here clearly I agree with him which is opposite than what the market is saying that low risk does not equal low return and high risk high return. He says that low risk can equal also high return because a well researched bargain is much less risky than a bond. In many cases there may be less real risk associated with buying a bargain issue offering the chance of a large profit than with a conventional bond purchase yielding about 4.5%. So here Graham tells us that when you do a lot of research when you really know something is discounted and the bargain it has low risk high return high potential return. On the other hand if you buy a bond with a 4.5% coupon if interest rates double then you lose 50% of your money which is very risky especially if it is a long term bond. So Graham agrees with me perhaps I got it from him and Buffett low risk high return investing. And now let's go on the portfolio location with bonds and stocks. Now everybody is saying that in relation to age you should divide you should deduct your age from 100 and that's the percentage you need to have in bonds. Okay that depends on a personal situation but Graham looks it from a different perspective from a market timing perspective where he says when stocks are overvalued you have just 25% in stocks. When stocks are cheap you have 75% in stocks and the rest in bonds. He compares the dividend yield with the yield on the bonds for valuations. The current environment is such that the dividend yield is 1.8% while the treasuries yield depending on the maturity of the bond is from 2% to 3% corporate issues 4% high yield 5.5%. We'll touch later also on high yield. So now you compare those two numbers and you see that bonds are a little bit higher than stocks the earnings yield is a little bit higher with stocks so you might see how are you going to position yourself there depends on your risk reward preferences. If you have a good appetite for risk and you can handle whatever can happen and that's something we're going to discuss today's forum tomorrow that we all think one way of what we can handle when it happens but then 90% of us will act differently and that's why I will make a video on how to prepare yourself psychologically for what can happen so that you can handle it properly and not to do the wrong thing at the wrong point in time. Nevertheless back to Graham he says that when stocks are expensive I think stocks are expensive now 25% of portfolio in stocks. Then in 1972 he was not convinced about his very conservative strategy even if he was spot on right but he was not convinced so he said 50-50 the best strategy and then if stocks go to 55% you sell 111 and then you are always at 50-50 and you change your rebalance in relation to 5% portfolio this balance so that's one way of looking at it. However the key to each strategy when you say okay I'm going to do this or I'm going to have 50-50 or I'm going to a rebalance between expensive and cheap is that you stick to it over the long term because that is more about managing portfolio risk than anything else and when you control the risk you are guaranteed you will reach those returns in the long term. However there is always the basic problem with such a portfolio location if you would have said in 2015 that stocks were expensive which they were historically you would have missed on this. So the SAP 500 is up 25% in the last three years and if you would have held just 25% of your portfolio in stocks you would have missed out a lot and on the other 75% you would have gained probably zero to 1% which is less than inflation as the interest rates were very very low. If an investor can act as a cold-blooded wearer of the odds he would be likely to favor the low 25% stock component at this time with the idea of waiting until the Dow Jones index dividend yield was say two-thirds of the bond yield before he would establish his median 50-50 position between stocks and bonds. So we said stocks are expensive let's now see what are bonds and the main question now with bonds is short term or long term that's always the question with bonds if you buy long term you fix the yield you are sure that you will get your coupons if you go for the short term you never know what will happen next year if interest rates will be higher or lower well as interest rates are still relatively low a little bit higher than they were a year and a half ago I would say that perhaps it's still better to keep short term treasury especially as the yield curve is flat. The yield curve means that the yield between the short term maturities and the long term maturities is not steep like this but is flat which means that there is not a big difference between long term yield and short term yield if interest rates go higher then the long term yield value of the bonds loses a lot of money because people are calculating in a higher yield therefore bonds are too risky now so I would say if you are a defensive investor to whom Graham is dedicating this chapter 25% in bonds and 75% in short term treasury maturities that give now 2.5% which is a good return if you're from Europe I don't know if you're from Europe try to find interest rates are going a little bit up depending what country you are in Europe there can be found some yields that are a little bit higher and safer. Don't look for high yield because that's very very risky you might be attracted by the five six seven percent dividend yield but those high yields are the highest risk of everything because when now it is five percent let's say the high yield when there is trouble that goes to 10 and it went to 22% in 2009 which means that the value of your stock of your bond can half or lose even 70% so it's not worth the five percent yield on the high yield junk bonds is not worth the risk. Here is the treasury yield curve you can see how it moved over the last three years in 2015 it was a little bit steeper with short term maturities yielding practically nothing and now it is much higher as the Fed has been increasing interest rates tomorrow I'll make a video about how the yield curve indicates that there could be a recession and what's going on in the economy based on what the yield curve can tell us. So the current problem is that stocks are overvalued but bonds can be overvalued too the best protection then is short term bonds when you know what you will get and you can always buy in the new yield a little bit later. The key takeaways for today are that it depends also what kind of investor you are defensive investor or an aggressive investor defend we are talking now in this video about the defensive investor so if you're a defensive you don't like risk then a high let's say short term treasury allocation would be proper if you are more aggressive we'll be talking more about that because then everything changes and I really think that we can find good investments even in this environment that will do relatively good over the longer period of time. As always Graham tells us that investing is about the risk reward and not just chasing the highest return all the time being patient even missing out on some gains will lead you to more stability and a certainty that you will reach those financial goals. Thank you for watching looking forward to your comments your cash bond stock allocation and I'll see you tomorrow in the video about the yield curve