This ever-liquid method also rarely calls for attempts to buy at the bottom, as bottoms and tops are actually impossible to judge ordinarily, while trends after they are established and under way can be profitably recognized.
It is a method that leans towards pyramiding; i.e., towards following up gains and retreating before losses. Such an account, properly handled, bends but never breaks. "Averaging down" is, of course, completely against its theory.
In normal markets, by which I mean active markets with broad varied participation and not unusually subject to unpredictable news developments, the belief that it is the right time to buy a certain leader will be so positive in the competent operator's mind that he will not hesitate to take a rather large position at once in one selected leading issue. This position will be much larger than if it were a segment of a diversified list, but, on the other hand, it will tend to employ a far more conservative
percentage of one's capital than would ordinarily be spread about the board by orthodox speculation or investments. There might be times when an investor would use 20-25% of the account in such a single issue, though this percentage would not apply in special cases where the amount of capital is very large or very small. There naturally must be a relationship between the amount of capital, the breadth of the market in a particular stock, and the tax bracket of the owner of the account.
If the market advances as expected, more of the same stock will probably be purchased. If the markets are narrow and highly dependent on news, little or nothing will be done. What is done will be on an ever-smaller scale as far as the initial commitment in any particular issue is concerned. If the shares go down, the loss will be small. If they go up, more can be bought. The theory calls for such large profits, if successful on the small amounts employed, that the account can get a satisfactory average return with a large part of its capital seemingly sterile. And there is always a generous reserve to try again in case of losses.
It offers complete protection against holding investments that seem very sure on the basis of all the known facts and yet decline marketwise. After a small decline, the ever-liquid method forces liquidation regardless of other facts. The fact of the market decline itself is the ruling fact of the situation. More often than not, many months and many points lower the real causes of the decline become evident to the "transfer it into your own name and lock it up" class of buyer.
At times, of course, a stock will decline for temporary reasons, and then start on a real advance. There is no rule against repurchase lower or higher as far as the ever-liquid account is concerned. In fact, repurchases at higher than the original or first liquidation price tend, in my experience, to return profits rather more than the average buy. The reason for this phenomenon is that the market, in getting stronger when the general expectation suggests it will get weaker, is, in fact, giving an A-l buying suggestion to those who will see it and are not afraid to follow it. However, the ever-liquid account, having taken a loss and being out of the market, is in a preferred position because
its owner goes back into the same stock only if conditions justify. He is not just locked in and hoping. In the interval of time, another issue may, on the revival of an uptrend, seem far more attractive. There is a lot of meat in these last two sentences.
This procedure puts a premium on ability. It is not easy. Lack of knowledge shows up quickly. Luck plays no part in it. The accounting reflects the real situation, and one is never kidding oneself with a taxable income from gains on a few coupons clipped, dividends received and profits taken while actually there exists a far greater unrealized loss in issues still held and "too low to sell."
The ever-liquid account is the acid test of successful investment or speculation. There are many other ways of making money in the security markets of course, but none that I know is so little dependent on luck or chance or where the results are more accurately reflected from an accounting standpoint.
I may as well anticipate someone saying "inflation." The fact is that liquidity and mobility are the great allies of safety against change. Intelligent capital is like a rabbit darting here and there to cover. Fixed investments, like real estate anchored to the ground, are far too inflexible for real protection against any hazard whether it is a tax hazard or a war hazard or a political or style hazard or what have you?
Hence, the "Ever-Liquid Account."
Medium and low-grade bonds, long and short-term, can be judged more like stocks. It is better to look at them frankly'for their appreciation possibilities. They can rarely be bought and sold in really large amounts, and are thus mostly interesting to small investors. When selected by an expert they are actually safer than many popular high-grade issues appraised conventionally. Thus I would rather buy a so-called "B" rated bond in a company on the upgrade than an "AAA" in a receding trend. That is another reason why selection of high-grade issues must be finicky. If they are at a quality ceiling, they can go up only if the trend of interest rates and purchasing power of money is judged correctly, but they can go down not only when these factors are misjudged but also if the quality rating is mistaken.
As a mathematical basis for appraisal, great care should be taken to avoid acceptance of loosely-worded statements as to the number of times interest charges of the particular issues in question are covered. This should be figured on an overall basis, including all prior charges, if any; and also total charges should be figured to help gain an accurate impression of the entire situation. As in the case of stocks, actual cash income should be set against estimated cash requirements including, on the one hand, cash received but allocated to depreciation, etc., and, on the other sinking-fund requirements, etc. Comparison of par, redemption or liquidation value of the issue under consideration and prior liens and comparison with the market value of junior liens and stock equities is usually illuminating.
The table on rates of interest compared with depreciation of money given further in the book is of paramount importance in relation to bonds.
In these times of fear of inflation and consequently fear of cash, bank accounts, and fixed capital and interest obligations, such as bonds, there is one point that certainly is worth mentioning here. It came to light, as far as I am concerned, not in any study of bonds at all, but in studying currency depreciation. Apparently, in times of extreme stress, there is more safety in a prime promise to pay than in a greenback. In Germany, for instance, during the 1920-1923 period, when marks were inflated by the trillion, many bonds fared better. Revaluation and
restatement laws helped a great deal. In the case of ordinary, commercial bonds, there were even samples where conscientious directors felt it unfair to pay off their bond holders completely with fiat money. There is no guarantee that what happened in the past will happen again in the future or that what happened in one place will happen in another, but the subject is worth thinking about. The owner of a prime industrial bond, like the German General Electric, came through the hyper-inflation panic with as much as 15% of his capital saved, depending on when he bought them, how long he held them and when he sold them. The general idea that he was wiped out completely is erroneous.
As mentioned elsewhere, devoting thought to the social and political aspects and occasionally the ethical aspects of such matters should pay off.
The really popular bonds with the investing public in more recent years are the convertible issues and bonds with warrants to buy stock attached.
Timing Convertible Bond Purchases
If you ask a bond man what special interest the individual investor has in the bond market nowadays he will come back and tell you that it is primarily in convertibles. If you press him still further he will tell you that from time to time the private security buyer will speculate on very thin margin in long-term U.S. Government bonds.
It was not always so. When I first began writing financial columns in 1921, buying bonds for income was the favorite personal investment. Today interest in bonds comes mainly from institutions. There are some wealthy private investors who buy tax-exempts. Occasionally when investors turn bearish on stocks some will temporarily turn to high-yielding bonds for income and to short-terms in the hope of greater price stability. U.S. Government bonds are of course the most widely held in the world.
Convertibles are popular because they seem under certain
conditions to combine a degree of bond dollar safety with a chance of profit. You can buy them on much more liberal credit terms than stocks. The actual figures vary but banks will tend to ask only 20% margin on a good active convertible that is not already selling at a high premium. It would take 70% margin under current rules to buy an active stock.
If you look at the New York Stock Exchange bond quotations you will see such bonds as National Airlines convertible 6's of 1976 quoted above 440; Macy convertible 5's of 1977 selling above 300; and General Telephone convertible 4 1 /2 , s of 1977 selling at 225. These bonds originally sold close to 100. These illustrate the profits that might have been made by careful selection, pricing and timing. You will also find some convertibles with high interest-rate coupons selling at discounts from par. This reflects their basically speculative nature.
The market price of a convertible bond is a combination of estimated true current investment value plus a premium for the current value of the conversion privilege, if any. This premium varies with the estimated opportunity to make a profit, the length of time the privilege runs and other factors.
The greatest care must be taken in buying convertibles, especially if you buy them on credit. The most common mistake is to look too closely into the size of the premium or the closeness of the conversion price on the bond to the current market for the stock into which it can be converted. I would suggest you look first into the stock for which it can be exchanged. If you are to make a profit, this must go up. You must start by being fundamentally bullish on the equity. Only then can you look into the mathematical factors governing the price of the convertible bond.
There are investors who will get their banks to finance purchases of government bonds on a 5% margin. For example, $5,000 on these terms will buy $100,000 market value of governments. Each one-point advance would amount to $1,000 less commissions. The greatest fluctuation here is in the low-coupon, long-maturity type of issue, such as the 3 1 /2% due in 1990. These sold above 106 in 1958 and below 85 in 1959.
Recently the long-term government bond market has been in a narrow range. In 1964 the low for these bonds was a fraction under 88 and the high a fraction above 90. There are those who feel wider swings are ahead.
You will find posting yourself on the bond market can be rewarding. However, if you turn to it because of the more liberal credit terms, be cautious for a purchase can be more speculative than in stocks.
See Chapter 32, Investment and Taxation, about tax-exempt bonds.
etc., seem to be magic to those unsuspecting who are often fleeced. There are good uranium mines just like there are good and bad in other endeavors, but it seems as if extraordinary vigilance is needed in this field.
Of course, fundamental to any mining investment are factors outside of the ore body. These include factors relating to a given mine, such as cost of production, and factors relating to mines in general, such as the metal or mineral price, taxation and politics.
The cost of production varies with each ore body and the depth to which it is mined as well as to existing labor conditions. National as well as local tax policies are important.
Politics enters into prices at times. Gold and silver have both been artificially controlled in price and the price of uranium is fixed by the government. Devices such as stockpiling often alter a price ordinarily fixed by supply and demand. Often wartime controls are a factor. Politics also enters into subsidies for increasing production, such as was seen in aluminum.
Despite these influences in normal times in most cases metal and mineral prices are usually affected by supply and demand.
Despite all these complexities, mining shares nevertheless have great interest and great value for those in a position to get the right information and evaluate it correctly. As in oil, many fortunes have been built from mining. After all, the important tax on a discovery is limited to the approximate 25% capital gains rate.
There is one relatively conservative method of investing in mines and that is through a mining investment and finance company. The outstanding one in this country is Newmont. There are some with the most excellent management, records, and reputation abroad. These companies have their own engineering and prospecting staffs and develop new mines in the field. Original expenses are paid out of pocket; successful prospects are financed and later capitalized, and, in part, distributed to the public. I feci the best ones arc more attractive (and also more speculative) than general investment trusts, partly for the rea-
son already expressed, that appraisal of mines is more certain than appraisal of industrial or rail prospects. Furthermore, their specialization is likely to be an additional advantage. The frequency of granting options in mining finance is often the source of really huge and unexpected profits, very often all out of proportion to risks.
A final word about gold shares. They long received prime ratings in Throgmorton Street. Over a period of many years, they came nearest to the perfect means of preserving current purchasing power for future use, i.e., hoarding of metallic gold where it is legal.
Gold companies are relieved of any effort to find markets for their product in contrast with the usual extensive and costly sales departments of ordinary business concerns. Furthermore, the price of gold has broadly increased for centuries.
Gold shares are devaluation hedges. The desire for gold is the most universal and deeply rooted commercial instinct of the human race.
Ordinarily, the chief threat to the quality mines is excessive taxation. Labor is occasionally a bearish factor. Competent advice will eliminate serious danger of any but occasional and unimportant losses due to depletion of ore reserves. Gold can for a time lose purchasing power, but to me demonetization is unthinkable.
As with other mines, the income return tends to be high and the fact that a return of capital is included is an advantage that is sometimes overlooked at first sight. Perpetual investments always eventually vanish, and the automatic amortization in the case of gold mines tends to release funds for expenditure in one's lifetime rather than to the tax collectors. They provide cash for constant reinvestment. This of itself is an important safeguard of capital.
Nevertheless, for a long while, chiefly because of political regulation but partly because gold like everything else moves in cycles, the times have been against them. They provide a perfect example of the importance of timing in all matters of invest-
ment. There can be little doubt but that eventually the price of gold will increase again. In fact, it could under certain conditions double overnight. This would be cold comfort to the investor who bought too soon and suffered patiently for many years.
market will take if he wants to sell, and, here again, the practical test will force one into the listed leaders where one belongs. A smart trader isn't going to put all his capital into poor collateral, either.
In the old days when broker's loans were at fantastic heights, the banks used to get a quick idea of the finances of the brokers by the makeup of their loans. If the collateral was all bundles of big active leaders, the bank's opinion was high. But if it was a mixture of new, untried specialties, then the expression was: "So and so is getting to the bottom of his box." Why buy securities that your broker will try to hide in the bottom of his box if his finances permit? Diversification is a balm to many who don't mind taking a chance on something a little sour in a mixed list, figuring on the better ones to pull it out and make a good average.
So buy only staples in securities; the kind that are "not included in this sale." I am thinking now of men's clothing in which all sorts of fancy ties, suitings and shirtings are sold at abnormal mark-ups early in the season and for what they are really worth at the close. But certain solid colored ties, white shirts, plain blue and grey suits, conservatively cut, are practically always excluded from the sale. Securities are not so different, and it is important to deal only in those that always, because of their nature or distribution, have a certain amount of residual interest. Be careful that in "diversifying" you are not supplying the bid for varying groups of narrow market issues that are the style for the moment because there is a special profit in trying to make them so.
Of course, we always have to remember that "one man's meat is another man's poison." The greatest safety for the capable I might say lies in putting all one's eggs in one basket and watching the basket. The beginner and those who simply find their investment efforts unsuccessful must resort to orthodox diversification.
I always feel that the less active a stock and the further distant the market, the more potential profit I need to see in it to make it worth buying. If one thinks he sees a potential profit
of 100% in an active New York Stock Exchange leader, certainly one would have to expect more to go to a regional exchange or over-the-counter or to a foreign market. This is a fundamental and logical principle.
Another angle of diversification nowadays is the fear of atom bombing and what it might do to property. Investors have looked to geographical diversification because of these fears whereas in more normal times, purely profit motives made for concentration. It is purely a personal matter whether an investor feels that efforts at safety from bombing are more important than trying to get the maximum out of investing.
There is a further diversification which I've never seen mentioned and which is important to consider. This is diversification as between the position of varying companies in their business cycle or as between their shares in their market price cycle. This is a very important consideration because dividing one's funds between three or four different situations which happen all to be in the same sector of their cycle can often be discouraging or dangerous. After all, the final determinant of investment success or failure is market price. For example, industries which are in the final stages of a boom with rapidly increasing earnings dividends and possibly split-ups, often offer shares high in price but apparently rapidly going higher. There is a sound justification for an investor who knows what he is doing to buy into such a situation, especially for short-term gains, but it would be quite dangerous for him to put all of his funds in three or four such situations. Taken the other way, naturally we all seek deflated and cheap bargains, but very often shares like this will lie on the bottom much longer than we anticipate and if every share we own is in this same category, we may do very badly in a relatively good market.
tion of geographic diversification, retention of capital in mobile form, and the keeping in personal touch with active business, both at home and in other centers.
One must keep personally active, alert, and in the swim. Retired businessmen, in my opinion, haven't much chance. One must not tie up all one's assets in one's home town or in a form that is not liquid and subject to easy shifts. There are far too many people who have a small business in their home city, their own house in the same city, and if they own any securities, some shares perhaps in the local utility company. In addition, their friends and business connections are all within a radius of 10 to 15 miles.
My real thought is that one's greatest assets are his mental competence to do something useful and his connections. Therefore, establish some emergency connections away from home. Establish a fund or funds away from home as well, both as a "calamity hoard" and as an aid to keeping your foreign interests alive.
For example, I think a trip to London is an education if the person making it knows how to get the most out of it. Meet the right people. When you come home, keep up your contacts.
It is growing very popular to combine business and pleasure for the real benefits that accrue as well as for the tax deduction. In order to get the deduction the business done must be real. I mention this because travel does not necessarily have to be all personal expense. The analysts societies nowadays fly a group of their members to Europe and Japan.
Many years ago, a very clever investor told me that time began at Greenwich and moved westward and so did everything else—ideas included. The social conditions affecting investment and living in England today are undoubtedly the most accurate foretaste one could get of the conditions with which we will have to cope in a very few years. Forewarned is forearmed and a visit to London to talk to bankers, brokers, and solicitors and observe what has happened to them and what they are doing about it to minimize the situation certainly should pay the larger American investor very well.
One can travel a bit around the U.S.A. and do a little diversification against calamity as well as discover some good investments just on their own merits.
Texas is perhaps the best place to visit in the U.S.A. along with Washington, D.C., and always, first of all, New York City. The leaders of Texas are aggressive and looking for capital gains and know all about finding oil, be it in Texas or elsewhere. Washington is the source of information concerning the governmental decisions that affect every investment. New York City is still the center and clearinghouse of everything from everywhere.
One ought to be able to move to several parts of this country and the world, and have enough friends to be happy and get a helping hand to start, and have ready at hand enough funds for a grubstake. Ask yourself how many widely separated places you could go to and make a successful new start in life.
Travel is a wonderful education and education is a wonderful hedge these days to those who can capitalize on it. One gets all the advantages listed above—a real vacation, a better knowledge of how to enjoy life, and an advantage over one's provincial competitors at home.
his surplus. Another might lose it in the market with the advantage that he might find himself losing something for "tuition" and gaining later lifelong advantage and security. As to the time required, it's of course possible, by working hard, to do a full day's work at one's regular job and still do a lot in the market. Most of the world works, ambling along, doing an hour's work in two.
One might very easily advance the argument that employers don't want employees "fiddling" with the market. In the case of banks, insurance companies, brokers, dealers and others handling money and securities, the reasons are obvious and valid. In industrial, professional and other lines I don't know that it's exactly a fair attitude, and I think it's important enough to pick a job someplace where the management is open-minded.
Nothing ventured, nothing gained. I have heard some people say they "never borrowed a penny." I have heard others tell me they borrowed to create a spur to force them ahead. It was usually the latter who won, provided the borrowing was done young and done for business reasons, for expansion and not to bolster up a failing situation.
As in anything else, there are various degrees of competency. Thus, for instance, there may be some who feel they cannot attempt the full program outlined here, and still they might feel able to judge when the common-stock tide was running in and when it was running out. Perhaps this might logically be done with proper assistance. If so, I suggest trying it, buying the best investment trusts which seem true cross-sections of the stock market. Buy those with the best and most honest management and those where all efforts are devoted to making money for the stockholders of the trust. More or less complete freedom for the management is desirable. Then there are the so-called closed end trusts which have a set capitalization and are quoted in the market, sometimes at discounts and sometimes at premiums from asset value. I ordinarily favor these over the open end trusts or mutual funds. The latter can expand or contract their Capitalization as the merchandising organizations sponsoring them find new stockholders or as the present stockholders de-
mand redemptions. The main idea is to buy when one feels a bull market is in progress; sell and hold cash when one thinks the trend is bearish. Don't expect the trust to do the switching for you.
For those with substantial funds who do not feel capable of even this, I rather favor the investment management department of a bank. One probably can find large established investment-counsel concerns with well rounded staffs that are perhaps more liberal and modern in their viewpoint. There are smaller concerns that revolve around one personality. Sometimes this individual is a genius, and during his lifetime his management is invaluable. However, the situation should be reappraised in the event of his death, and this type of firm should never be mentioned in a will.
Thus we get back to our primary argument all the way through this book that a great deal of personal judgment is necessary if one is to succeed. If it's not a case of judging stocks, then it's judging men. However, when the minimum of judgment is likely to be used, I favor the bank above the average counselor. He will be more orthodox, and if one can't be 100% unorthodox and win all along the line, then by all means go the whole hog the other direction and don't experiment in between. Select a New York City trust company, preferably one with a few large accounts rather than a host of small ones.
Finally, I am asked, what about the power of attorney? What about trying to get a broker to run one's account? What about an investment counselor of the individualistic type rather than the big counsel concern? Here we get back to the psychology of selecting the right man, to say nothing of having him willing to take the account. And your contribution must be to put him so completely at ease that he will do what he thinks best without fearing your possible unfavorable reaction. Personally, I think there are a few who will succeed with this. I think the odds are too much against one really to advocate trying very hard along such lines.
I have tried to write out frank conclusions from my own observation and experience, derived from attempting to invest
as a private client up to 1921 and since then as a professional, who has handled an enormous number of shares. I think I have stepped on other people's toes; but no more than on my own. Most of what is said here comes from practical experience. Still I realize that quite unconsciously what seems easy and natural and logical to me might seem utterly impossible to others, and likewise that people of different natures and abilities might succeed far better than I can ever hope to, following entirely different policies. One can decide to travel by foot, on the back of an animal, in an animal-drawn conveyance, on a bicycle, train or motor, on a ship or a plane, and still arrive at the same destination. Hence, I am altogether open minded on the whole subject.
The most important thing I have learned over the last 40 years in Wall Street is to realize how little everyone knows and how little I know; luckily I learned that lesson in 1922 and 1923 and not in the period from 1929 to 1932, when it would have been costly. One of the shrewdest speculators I know once remarked that if some supernatural power could guarantee him for the rest of his life maintenance of the purchasing power of one quarter of the quoted value of his cash and securities today, he would quickly hand over the other three-quarters in payment. But he sadly concluded it couldn't be done. This is the realistic way people who think straight look at our situation today—not in terms of "6% and safety." It is an advantage to be old and haye lived life; our children face uncertain times.
The most important things any reader of these chapters can learn are likewise that investment and speculation are difficult, not easy; uncertain, not clear-cut; treacherous, not logical. Here, more than anywhere in the world, is the land of illusion. Things are not what they seem. Two and two don't always make four. "Stocks were made to sell." Caveat emptor —"Let the buyer beware."
also by the way the cost or availability of things is altered by sales taxes and rationing. The buyer of a motor car in England in 1913 paid no "purchase" tax, as they call it, or at most a trivial one. The buyer, a few years later, not only paid a purchase tax equal to the cost of the vehicle but also had to wait some years for delivery if indeed he could procure a car at all. People in Japan today who have the money to install telephones cannot get them. They have to go into the black market and pay high to buy someone else's listing. Higher sales taxes and the unavailability of products and services thus often work to depreciate the value of savings in the same way as rising prices.
The tendency of most people who have the knack of making money is to keep making more and more. If a dollar were always a dollar, it would be easy to work out a forecast of retirement needs and often avoid over-spending or over-saving. However, we all are plagued by the fear that the cost of living may rise faster than our retirement and emergency provisions. This fear is real, as many annuitants, pensioners and endowment policy holders know too well.
I remember visiting the Temple of Angkor Vat near Siem Reap in Indo-China, and chatting with the French manager of the hotel in that hot, humid spot. He told me that for years he had been working there in self-chosen exile from his native France, to accumulate a quantity of francs that would enable him to return home and retire modestly. Needless to say, by the time he reached his goal, devaluation of the franc had wiped out most of the value of his savings. All his sacrifices were in vain. He might just as well have lived at home and spent moderately as he went along, enjoying his life from day to day instead of waiting for his ship which never came in.
The human capacity for enjoyment decreases at a fast rate, both by age and quantitatively. A cup of coffee means a great deal to a cold, thirsty man. The multi-millionaire gags at drinking more than two or three cups. Also, the man of 30 will enjoy a world cruise more than when he is 65. Usually, however, the pocketbook is longer at 65 and of course time is more available. The man at 65 might enjoy a rocking chair or his petunias.
My philosophy in these matters leans to denial early in life to build a competence, later to maintain it at a productive level, and to spend any excess rather than let it build up geometrically. In the end, it only may lose its value, or go to the inheritance tax collector.
As to the question of a proper division of available funds between immediate and future spending, there can be no doubt that the amount to spend at various periods of a lifetime often becomes an investment decision, though not always recognized as such. At the start, when one first goes to work, the amount of saving and spending is almost certain to be regulated by individual economic factors. There is no point of discussing what to do, or not to do, until earnings grow sufficiently to offer a choice. Earnings at first are likely to be close to the subsistence level, or below. Even so, in many cases, an element of choice does exist. For example, there frequently is parental assistance, or inheritance.
These choices should be seen clearly and appraised objectively. Interested as I am in investment and the earliest possible creation of a fund with which to begin, I naturally counsel conservatism in spending during youth. However, in reality, all of us have first an investment in ourselves as earning individuals, and next an investment in our savings or inheritances. So when I counsel a frugal course, I mean mainly as to diversions. Money invested in one's self, be it for education, appearance, contacts or good health, is another matter. It is, of course, obvious that alliances which on the one hand build monetary overhead and responsibilities, and on the other steal time, logically play no part in any well-thought-out and aggressive program of advancement and savings, or, to put it more bluntly, marrying before one's ship comes in.
Spending casts a shadow to the end of a spender's life. The cost of a luxury expenditure to a successful investor may be very high. For example, if an article costs $1,000 at age 30, and this capital otherwise could be used for profitable speculative investment, the real cost of the article if bought keeps growing with the years. The object itself gradually depreciates to a zero
value. On the other hand, one thousand dollars successfully invested becomes $2,000, then $2,000 becomes $4,000 and so on. This is what I mean by spending casting a shadow to the end of one's life.
The creation of a fund for investment can be accelerated by using other people's money as capital as much as possible. For instance, it is the utmost folly for a young man to divert capital into buying a home while he still needs a fund for investment and before he has reached his financial goals unless he has abandoned them as unattainable as far as his mentality is concerned. Let the landlord get his rental out of his house capital if he can but you get the use and profit out of your money. Of course, where the government furnishes most of the capital for a home on long term amortizing loans the buyer can have both his capital fund and his home. In fact, as his investment aims are very high and the government interest rate very low and as the amortization plus general social policies practically prohibit foreclosure, a veteran for example offered such a deal often has a good thing. However, the mathematics of the situation must in each case be carefully figured to make certain the advantages over renting are real.
All of this is designed merely to help readers lay out their investment and spending plans. Each of us has to decide between spending and saving, just as we must choose between working and playing. The tendency in early years is to overspend and in later years to under-spend. The average younger man will do better to think more of the future. The older and more successful man will do better to think of the present. Successful individuals who have found the key to profits sometimes seem to get on a treadmill of grinding out more and more profits, forgetting that as they get older, the span of life and the capacity to enjoy it keeps diminishing.
parts, concerning the tax shelter or lack of it in the corporation itself, and the tax situation as it applies to the personal tax of the investor. It begins with the type of security involved. Foremost in this category are the tax-exempt bonds outstanding and still being issued by the various states of the Union, counties, municipalities and tax districts, etc. These bonds are "tax exempt"—the owner does not pay any Federal income tax on the interest received. They fluctuate with changes in money rates and the credit conditions of their various issuers.
Unsuccessful efforts are made periodically to overcome their tax-exempt status.
Despite their tax-exemption, these securities are not as desirable as they might appear at first glance. With rising taxes, they have become so much in demand that they sell at high prices and at low income yields. Buyers ordinarily figure their tax bracket and compare yields from taxable income with tax-exempt yields.
Thus, a person with a taxable net income of about $50,000 a year, filing a separate return, would, at 1964 rates, be approximately in somewhat more than an over-all 40% bracket and pay a tax in excess of $20,000 a year. He would have to secure a 2% % taxable income to leave him with the same amount net as a \Vi% return on a tax-exempt bond. The same individual would be close to the 60% bracket as regards the last few dollars of his income and would have to secure almost 3%% of taxable income to leave him with the same amount net as a 1 V2 % return on a tax-exempt bond if he were figuring "off the top" as it were. If it's a question of a prime taxable bond versus a prime tax-exempt, the mathematical conclusions will be correct.
If it's a question of investment policy, however, then all the characteristics of any type of security under consideration must be taken into account. Net income from interest coupons after taxes then becomes only one of several factors, and in my opinion, not in any sense the determining factor.
Tax-exempt bonds, like prime taxable money-rate bonds in general, have no inflation-hedging characteristics of any kind. Therefore, many wealthy investors, in times when they feel the
purchasing power of the dollar is decreasing, prefer common stocks for capital gain possibilities that might offset this loss, even though their net income from dividends, after taxes in high brackets, leaves less net income than does an equivalent investment in tax-exempts.
Tax-Sheltered Stocks
There is another category of temporary and partially tax-exempt income. It can sometimes be procured from the stocks of companies with large tax credit carry-overs, resulting from previous losses. In some cases, following a recovery in earnings or profits, such situations allow the payment of so-called "tax free" dividends for quite a time, or totaling quite an amount. I say "so-called," because actually these dividends are usually free from ordinary income taxes, but not from capital gain taxes. As the latter are smaller, the advantage varies with the tax bracket of the buyer, but often is considerable. There are also certain mining companies paying out more in dividends than current earnings whose annual payments are rated partly income subject to tax, and partly a return of capital and hence not subject to tax.
Stock Selection
The tax advantages of mining and oil stocks are very important. Under present laws, they are allowed as much as 27^% of their earnings tax-free in order to give an incentive to discover and develop additional resources. This amount is charged as depletion because obviously material removed from the ground is gone as a productive asset forever. They are also allowed to deduct costs of drilling dry holes or unsuccessful exploration. Put another way, this means that companies of this type not only have considerable tax shelter but are also in a position to utilize their earnings in a way calculated to build up property values. Shrewd investors prefer capital gains to dividends.
To a lesser extent, investment in ordinary growth companies, where dividends are low and reinvestment or plowing back of
earnings is made into research for new products or the development of increased production, is advantageous.
It is important to consider the investment price paid for such purchases. Very often, the advantages of owning such stocks are so well known that the premium in the market becomes excessive.
Regulated Investment Companies
Individuals who hold stock in certain types of so-called "regulated investment companies," paying out 90% or more of their dividends and profits, are allowed to treat the capital gain portion of such dividends just as if it were a personal capital gain. Thus, assuming that the trust's management is capable, this is a method of securing larger dividends, and avoiding the ordinary bracket taxes on a portion of them.
Small Business Investment Corporations
The small business investment corporations, or "SBIC's" as they are termed, are granted special tax privileges. If you own stocks in such companies at a loss you can take the loss and write the entire amount off against your ordinary income.
Advantageous Tax Base
In times of excess profits taxation, investors should look for tax shelter in companies possessing satisfactory invested capital or average earnings tax bases so as to assure maximum excess profits credit. Companies with heavy recent losses that can be carried forward are often interesting, but the investment consideration of an improved future outlook is more important than the mere tax shelter.
Capital Cain Taxes
However, in general, income from securities is fully taxable at ordinary income tax rates which rise on an ascending scale to astronomical percentages.
Special lower capital gains taxes on profits from purchases and sales ordinarily apply only if a security is held for a specified length of time. These taxes generally tax only a portion of the gain, and generally have a maximum percentage rate which is not exceeded no matter how large the total profit of any one individual.
Because the tax on capital gains is lower than the tax on ordinary dividend and interest income, large investors favor companies with maximum growth potentialities. They favor management that can profitably "plow back" into the business the highest percentage of earnings and pay out as income as little as possible—sometimes nothing at all. In the long run, income-paying ability has a definite market value and companies with safe dividends are valued higher as a consequence. Smaller investors buy such shares for yield. For the investor in the high tax bracket, buying a young, non-dividend paying share for ultimate profit and holding it for sale until matured and established as a steady dividend payer, is far more profitable than owning a steady income share which returns a high annual gross yield.
There are often cases where a share that returns a high dividend also has maximum capital gain potentialities. This develops when investors incorrectly question the safety of a high yield, or when a company becomes so strong that its trade dominance permits re-investment of earnings and good dividends as well. In such cases, the low bracket investor buys for income and gain—the high bracket investor ignores the fact that most of his apparent income is taxed away, and concentrates on the capital gain prospects. The net income from dividends after taxes may often be under that of a tax-exempt bond, but if the profit potentialities are there, that is the determining factor.
For some years, in the United States, the required holding period for receiving the benefit of the long-term capital gains rate has been six months, the portion of the gain taxed 50%, and the top tax rate under these circumstances was 50% of the one-half of the gain. This has meant that an individual reporting what is termed a "long term" capital gain has had in most
circumstances a top tax of 25 %. This is very important to those in both high and low tax brackets; in the first instance there is usually a definite tax ceiling and in the second only half of the gains are taxed.
As a result intelligent investing policies should be geared to the tax laws. The law at the time of investing or closing a transaction should be closely studied. It is changed frequently. As written in 1965 it is necessary to think of taxes all during the year and not just in the last few days of December. Short-term losses, which means less than six months, are particularly valuable if they can be evenly matched with short-term profits. Profits are usually taxed lower if held over six months. Note that the law provides that losses can be deducted right up to the last trading day of the year. Profits, however, have to be established usually four trading days previous to the end of the year. If you delayed overlong in establishing your profit you can tell your broker to sell your stock "for cash." This will hold up to the last day for profits but is normally done at a slight discount.
There are those who attempt to postpone registering profits for tax purposes by short sales against the box. I strongly advise investors not to make any transaction except the normal simple ones without consulting competent tax counsel.
It would seem profitable for anyone, regardless of his probable tax bracket, to attempt short-term trading in the early part of a new calendar or tax year if market conditions are favorable. This policy, when successful, tends to build up a profit much more valuable as a future tax cushion than for its own sake. Later, commitments originally entered into for long-term capital gains, may turn out badly and the loss be offset by the earlier trading profit.
Furthermore, consideration should be given to accepting a certain average amount of capital gains each year, if one's position and the market happen to favor large paper profits rather than permitting them to accumulate. The trend of tax legislation has tended (most of the time) toward higher rates. This is true despite the reduction in 1964. Unfortunately, it probably will not be long before rates start rising again. Paper profits can go
as well as come. Tax legislation has been known to be enacted so as to operate retroactively and while no one can foresee the nature of such future laws an average position with a consistent yearly tax is most likely to be helpful.
The Logic of Taking Taxable Profits
One of the great fallacies of investor tax policy is to reason incorrectly that one cannot afford to take a profit because of the size of the tax. In most cases, investors feel that unless the market price of the shares in question promised to drop enough to equal the full amount of the tax, the gain has been accepted in vain.
The fact is that every paper gain is only the amount of the gain less the potential tax. Thus, if a stock is bought at $100 a share and advances to $140, the owner at no time has a 40-point gain. He has a 40-point gain less his tax, whatever it might be. Assuming it to be 25%, his real gain is only 30 points, whether he turns it into cash or otherwise.
Should taxes increase, his gain would be reduced. Should the market break, his gain might vanish.
Possible Drawbacks
Considering the advantages, the possible drawbacks against accepting some gains regularly, if available, are small. In the case of very old people, for example, a capital gains tax is entirely avoided in the event of death as a result of the law which provides for valuation at the prices prevailing at the time of death. The personal estate tax in this event would be greater. The future tax advantage resulting from the new and higher scale of valuations would, however, pass to the inheriting party or parties instead of to the real owner of the securities.
Then, too, the laws governing loan values often work to decrease the amount that can be borrowed on a repurchase after taking a profit.
True, in a sense, the owner of a stock with an unrealized gain, and an unpaid potential tax, has the use of the money he
eventually will pay as tax, interest free, as long as he doesn't sell his stock and turn his paper gain into a real one. Thus, after a profit is taken and a tax is paid, unless the stock sold declines the full amount of the tax, a lesser number of shares only can be repurchased with the proceeds. This is a more imaginary than real disadvantage and actually sometimes an advantage, because it usually occurs when stock prices are relatively high. Of course, should the stock sold decline more than the tax paid, and should the investor then desire to repurchase, he can repurchase more shares than he originally owned; so it works both ways. The law at present allows the sale and immediate repurchase of the same stock where a profit is involved, but demands a 30-day waiting period in case of a loss. Losses are not deductible where the same stock was repurchased inside of thirty days.
It can be seen from this discussion that examples in a complicated situation of this kind can be very misleading or misunderstood. The important facts, however, are that the tax must be paid sooner or later and that most people make the mistake of not selling because they feel that in some mysterious way they are avoiding the tax. The person who operates on investment principles always will come out better.
Deducting Losses
To touch on another angle of the tax laws, the method and amount of deducting losses is of great importance. The rules change. Currently, most stock losses are first deducted from other stock profits. If there is an excess, the first $1,000 can be taken off ordinary income. The balance of the loss, under the present law, can be carried over indefinitely. Long-term losses carried over must first be deducted from future long-term profits and short-term from short-term. The excess can be deducted at $1,000 a year from ordinary income. The losses are carried forward until they are used up in one manner or another. In the event that the investment position of stocks held at a gain is favorable it is of course possible to take the profit and repur-
chase them immediately. The effect here would be to secure the tax benefit of matching the profit and loss and through the repurchase increasing the tax base.
Tax Dodges Good and Bad
Every now and then, supposedly shrewd investors devise some tax dodge that seems legally to play hob with the spirit of the law. I am against this sort of thing. Sometimes it will be sustained but such loopholes usually are closed in time. However, there are certain practices which seem both legitimate and logical. Buying bonds that are in default of interest but are about to pay off, and selling them for capital gains on the advances which discount the interest payment, is one.
It is vital for the investor to realize that a correct understanding of the tax factors is almost as important in most cases, and more important in some cases, than a correct understanding of the investment factors. Knowledge of one without the other is sure to detract from the results.
Miscellaneous Tax A ngles
There are many variations in achieving the best tax policy and the laws are changing frequently. Tax experts and current tax manuals are essential.
Current tax laws add a new element in making it essential to consider the effect of spacing between years. Taxes are frequently saved by taking losses in a different year than profits. The system of clubbing varying capital transactions creates new complications.
The 1964 law includes an averaging provision that is occasionally of value in saving taxes where a large short-term windfall profit has been achieved.
You should understand the deductibility of state transfer taxes and how you can take a tax deduction for interest paid on a margin account.
In buying investment trust stocks, it is important to compare the cost of their investments with their current market value.
Liquidating values ordinarily make no allowance for taxes on unrealized profits. Consequently, it is quite easy to actually buy one's self a tax liability, as it were. This is particularly true of mutual funds which never sell at a discount and always sell at liquidating values without allowance for taxes on unrealized gains plus merchandising loads.
Holders of stocks in high tax brackets, where unusually large dividends are about to be paid, often can profit by selling before the stock goes ex-dividend and thus having the dividend treated as a capital gain rather than as ordinary income. This is particularly true where some large unpaid arrears are paid off.
Charitable Contributions
The law currently allows the deduction of charitable contributions to certain public charities to the extent of 30% of adjusted gross income. Not over 20% can be given to approved private foundations. For high-tax-bracket individuals this means a comparatively large sum can be given away with a relatively small net loss in income due to tax saving.
Contributions can be made in the form of securities bought at a low price. The gift is calculated at the market price but no capital gains tax has to be paid.
Charitable contributions can be carried forward five years. Thus, if a contribution made in one year totals 40% of your income, 30% can be deducted in that year and 10% in the following year.
Capital Gains Not Income
The capital gains tax itself is unsound. It has caused great damage and promises still more. It is the cause of fallacious thinking on the part of the majority of the American investors. Imaginary capital gains are regarded as real income, and personal expenditures are foolishly overdone on such false premises. The tax has caused market rises to go to extreme and dangerous lengths. Tax receipts have varied unnecessarily because of its application.
I have seen people who thought they had made $10,000 in the stock market—because the Government called it "income" they treated it as such, and unknowingly spent part of their capital.
Anyone whose invested stock capital appreciates slower than dollars are depreciating, measured in stock averages, usually at some point and some time continuously, pays "income" tax for the privilege of losing purchasing power.
Even if one makes a real profit by any standard in the market, it is not "income" and should not be taxed as such nor regarded as a source of funds for current expenditure. In most cases, it is distinctly "non-recurring."
Investment Principles
To what extent, if at all, should one retain stocks which would otherwise be sold, so as to diminish the tax?
Personally, I usually sell when I am so inclined, regardless of tax—and give tax-reduction consideration from other angles rather than refrain from profit realization.
From the point of view of the average investor, I don't concede the possibility of buying at the bottom and selling at the top. Instead, I think most people will have the fewest stocks at the bottom, and a rather larger-than-normal line at the top. Thus, in actual practice, a much smaller actual decline than the preceding advance will wipe out all profits, because the average trader's real losses occur on more shares than the number on which his paper gains were established. This is what happened in 1929, and what will happen again in time, only with greater violence.
Two other great advantages of accepting profits without tax delay are: First, that the profits are real, and the method of obtaining them is more a regular business practice and less a matter of chance. No one can take profits consistently over a period of years in the stock market without real knowledge; yet, many occasionally stumble into profitable commitments. Usually, the gainer thinks he has found a new source of wealth,
much to his eventual cost. Secondly, as each transaction is closed and a new one initiated, the price of the new purchase is the only price taken into consideration in calculating risks or taking short losses, etc. Many people who bought stock in the middle stages of a bull market felt no fear around the top because of their seemingly low average, which in a subsequent decline actually proved high. Purchases and sales through such a rising period would probably have resulted in some eventual buys at very excessive figures. Realization of the great danger involved would cause a prudent trader in the latter situation to buy less and sell at once if the market turned sour.
Short-term commitments are naturally made in the issues that seem the most attractive. Long-term positions, held past their best time for tax reasons, frequently result in ownership of shares which have lost their market leadership to another group.
For the competent trader and investor, consideration should be given to the rate of return received on capital, regardless of the market outlook. For example, if $100,000 grows to $150,000 in six months and the market looks higher, but is obviously vulnerable to the unexpected, I think taking profits for the big returns they bring and paying the tax is the proper procedure. Most people, especially investors try to get a certain percentage return, and actually secure a minus yield when properly calculated over the years. Speculators risk less and have a better chance of getting something, in my opinion.
As an alternative plan for those who are so greedy, they cannot, without mental pain, watch shares they have sold climb higher, I suggest initial overbuying of a combination trading and long-pull line. This has several advantages. One is more careful entering into the larger commitment. The whole line is sold if the stock works out badly. The trading line is sold if a profit occurs and the profit is applied to marking down the price of the long-pull line.
A third and more scientific policy is to earmark funds for long-pull and for trading. The long-pull purchases must be selected with a view to holding, for tax reasons, through all
sorts of vicissitudes; hence, seeking the very highest managerial ability becomes a factor that outweighs any other.
Deductible Expenses
All expenses reasonably incurred in the process of attempting to acquire income are presently deductible tax-wise from your gross income. This includes the state taxes on the broker's bill. It includes professional help, such as investment or tax counselors, statistical and advisory services, etc. In the case of large incomes which have been built up because of trips and other costly contacts, these expenses can also be deducted. The cost of this book is deductible but check it when you make out your return.
Conclusion
The good of the whole nation would be served by repeal of the capital gains tax. The political climate being what it is, this seems unlikely. Modifications easing the burden might develop in the coming years. One of the most constructive developments, and a very logical and fair one, would be to postpone payment of the tax until securities were liquidated into cash. Exchanges would be permitted without tax. They are permitted now in certain real estate transactions. In the meantime, the good of the individual will be advanced, in my opinion, if he disregards it and sells when selling is indicated and pays the tax bill when incurred. All careful traders constantly set up a reserve for this tax anyway, so that if one gets in the habit of thinking of paper profits, less current tax, it is not so difficult to trade freely and not run the risk of missing one's market.
then, for the majority, only complete financial ruin and extreme emotional uncertainty follow.
The control of inflation is rarely attempted at its roots, where control is possible, but practically always is instead incorrectly directed at its effects, where such efforts invariably fail. If it runs far enough, it brings its own cure, only by that time the patient is dead.
Deflation, on the other hand, is less disastrous in its final effect on the individual, though generally associated with "hard times." It is also far easier to check and turn, mainly because the methods adopted have general and hence political popularity.
People, by and large, most of the time, cannot, or refuse to recognize either inflation or deflation, but mainly count their wealth as well as their income, gains and losses in dollars. Thus, the average man almost always feels better, with a larger number of dollars, even though they buy less, than a lesser number of dollars, with a factually larger actual purchasing power or value. Human nature being what it is, no change in this attitude is ever likely, hence the very long pull value of money tends to decrease, and the very long pull value of things tends to increase. Human propensities to propagate and to spend, rather than save, also add fuel to the fire. In general, the very long pull trend favors the forces of inflation over those of deflation and by and large over the very long pull the owner of equities is better off than the owner of bonds. This is an extreme oversimplification of the subject, because the swings up and down cover long periods of time and changes in value, and as a matter of practical everyday success in life, some measure of reasonably correct forecasting is necessary.
Furthermore, statements made as to what to do about it, or commenting on the past effects of similar movements, are apt at best to be highly invalid, because what is true at one stage of inflation or deflation is not true at the next. Or for that matter, what is true in past inflation does not always prove true again. Different inflations spring from different causes. The soil in
which they grow varies. The degree to which they run differs. The key to safety under one condition will never fit succeeding situations.
Deflation
Taking up the subject of deflation, first of course cash is the easy and perfect hedge if one can recognize the trend in its beginnings. There is no tax problem involved in a deflationary period, because monetary values are decreasing, even if sometimes real values are not. All security markets stocks and bonds together naturally decline. Stocks decline because both earnings and balance sheet values are reduced by the rising value of money, and also because of liquidation induced by the greater need for money resulting. Bonds decline, because in most cases interest coverage and security behind the principal decrease, but also for reasons of holders seeking or requiring increased liquidity. It is true interest rates decrease, and this tends to bolster very prime credit risks, but in a period of this sort prime credit is rare. An important investment principle to bear in mind is that in times of deflation stock prices invariably drop much more in market value per annum than any dividends the securities in question can conceivably pay. Thus, keeping liquid (in cash) and living off capital actually results in a smaller annual net shrinkage in capital value than attempting to secure so-called "income" for this purpose. Also, eventual profits and often real fortunes are built by buying at the turning points of great depressions. However, unless cash is on hand to buy bargains these opportunities cannot be utilized. In short, hedging against deflation is simplicity itself and involves nothing further than being long of cash. The difficulty comes in recognizing the oncoming depression before security values are already deflated, and in having the proper objective mental attitude that permits keeping cash "idle" and "living off capital." Of course, these two phrases, used in this way, are classically the language of the uninformed, and basically completely fallacious. Cash is far from "idle" if what we wish to buy with it is constantly decreas-
ing in price. Nor are we "living off capital" if the major part of our capital is constantly acquiring more value.
A very potent type of deflation is a collapse in the price of a single commodity. This affects securities where the link is obvious. Thus, copper stocks are affected by the price of copper and sugar stocks by the price of sugar, etc. In recent times this is almost the only type of deflation in which we seem to come in contact. It must be guarded against because owning the wrong securities even in inflationary times can result in big losses.
Inflation
It is when you reach the subject of investment policy under inflationary conditions that the real complexity of the situation begins to unfold. True, at the start, "inflation" is nothing more actually than "recovery" or a "turn for the better," etc. Under such circumstances, the ownership of good equities will result in equally good income and profit. Everything will be low and moving higher. Corporation profits naturally respond to increased demand for goods. Slightly rising prices make for inventory profits and satisfactory profit margins. Costs are still lagging. Social legislation is apt to be at a minimum or favorable. The entire investment climate is good.
The step from one stage to another can hardly be definitely tagged, but the next degree might be called the high-cost-of-living period. Here, inflation begins to pinch in places and its rate accelerates. A great deal depends now on the force behind the movement, but generally, if inflation is to go beyond this point a major cause such as preparation for war, or war itself, or the aftermath of war is likely. War of necessity unites a nation behind the party in power and speeds social reform. The supply of money and credit is increased and the supply of goods and services decreased. Production is to the greatest extent possible for destruction rather than consumption. Efforts are made to "control" the situation through taxation including excess profit taxes and more and higher excise taxes, through rationing and in some cases even capital levies. Investment policy now is
much less assured. Equities still seem the best, but a great deal of question develops as to the length of time the inflationary trend will persist, and the extent to which its force has been discounted marketwise. Fear also begins to be expressed as to the deflationary effects of taxation, profit squeezes, etc.
The situation may turn here or it may go into what might be termed hyper-inflation or super-inflation or uncontrolled-inflation or what have you. This of course is the utterly wild type which practically demands printing press money. Values change so rapidly it is hard to know what anything is worth. Business management is extremely difficult. Stocks go up but nowhere near as fast as money goes down. Eventually, the mental strain on the population and the incapacity of the majority to keep up with the situation causes so much ruin that a "stabilization" and revaluation is forced. Under such conditions of course cash and fixed obligations in general are usually wiped out.
Common stocks under such conditions have on the whole fared better, but nothing to the extent indicated by popular and uninformed general comment. The general theory that a common share is a share in a piece of corporate property and hence if it is a given fraction at the start of an inflation it is still in the same fraction at the end is in itself erroneous. The need for working capital under inflation and other considerations are often so great that new equity financing naturally follows and results in a great equity dilution. Or, if this is shrewdly avoided by the management then the necessity of attempting to convert "paper" corporate profits into more factory or more resources is not always understood or if understood is not always feasible. In terms of market prices stocks at times are inflated beyond values by fear buying, and at others lag behind values by lack of liquid funds to buy, so great is the need for money. Interest rates of course would become astronomical, unless artificially checked, because the effort would be to fix a rate high enough to keep up and somewhat surpass currency depreciation in the borrowing period. The average buyer, buying a list of average stocks, at average times and prices along with the crowd will not do well.
It is impossible to express the situation in any mathematical way as to how much a person might salvage because of the myriad variations of the situation. However, as an eye opener to those who without study blindly think that stocks protect against inflation, I have seen figures showing stock losses in inflation on a gold basis running as much as 97% of pre-infla-tion capital.
My conclusion as to practical inflation hedging in the U.S.A. is that little can actually be learned from a study of inflations which occurred in other countries in years gone by. Primarily, the causes and extent vary, but even more importantly the legislation and controls and tax policies which go with it keep changing. I would say they are modernized as the years go by or to put it another way the loopholes of past inflations through which clever people salvaged their wealth are watched and plugged in future ones.
I think in the final analysis such policies are fixed by political expediency, and I would always examine from a social angle any special "scheme" to circumvent losing with the rest. Political expediency was responsible for our default in going off the gold standard. It was responsible for otherwise completely unfair mortgage moratoriums. It was responsible for equally unfair rent ceilings. If the majority of the voters prefer their bonds and insurance policies paid off at par in dollars of reduced purchasing power to being paid off at a discount in hard dollars, or best of all living within our means and thus being able to pay them off at par in hard cash, then it's such living beyond our national means and fooling ourselves with paper dollars that will prevail.
The paternalistic policy of creating government agencies to set up an insurance fund and "guarantee" against loss is often a contributory inflationary factor. Land prices, labor and home construction costs, for example, are boosted by insuring certain savings and loan investments up to $10,000 per account.
However, the very rapidly increasing productive capacity of U.S.A. factories is a deflationary factor of very major importance, and deserves fully as much attention in evaluating the
situation as the purely monetary factors. It is likely that more will be lost to the American investor in the years to come from the tax factor than through currency depreciation, hence the two subjects should be studied together.
It is unlikely in an exporting country like ours of such great natural resources and productive capacity, that unbridled inflation will ever rule as far as we can now see ahead. I think given time and especially given another world war, a 25-cent dollar, a 10-cent one or worse can happen. But the inflations of the Russian and German type—I think in Germany the mark went to 40 trillion to the dollar—seem completely unlikely here.
Investment policy under such conditions calls for major attention to determining whether the dollar is appreciating or depreciating, and the extent to which stock market prices under-discount, discount or over-discount the situation. All through these articles, the theme of "purchasing power values" has dominated, even when inflation was not on every tongue as it is today.
Success in investment under varying dollar values thus comes down to success in investing. The two are one and the same thing and the investor who thinks he is buying special "inflation hedges" is more apt to get into trouble than keep out of it. Stocks are only good inflation hedges if bought at the right time and at the right price. And the same rule applies regardless of what the power behind a rise might be. Practically all upward business cycles occur with prices rising, so that whether tagged inflation or not the impetus is usually the same. The only special advice I can give is that the better the quality the better the chance to survive if the road grows really rough. The best inflation hedges lie among the best managed companies with the best long-pull outlook for consistent profits and growth. The special debt ridden issue that is going to be bailed out by inflation—the marginal producer which is going to benefit from the stimulated demand—the company with a "tax shelter" built up through inefficiency—the high cost natural resource share—all this kind of inflation hedge offers only trading, in and out, possibilities. In the long run, they arc bound to fail. The danger in buying them
lies in the danger that when one is ready to switch to the real companies, the latter will seem too high, or the tax penalty will appear too great.
In these times when the revolt of the masses leads more and more to the leveling of the classes, a great bulwark against loss through inflation, social legislation or taxation is to consume as you earn. Buy the fruits of others' labors with the fruits of your own—at the same rates. It's a great time and age for hand holding and paternalism, and I don't advocate completely becoming a ward of the state by no saving at all, but I do think it should be kept within bounds, the thinking of the world being what it is today.
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Postscript
The Battle for Investment Survival ends on page 153. This Postscript, consisting of miscellaneous individual articles, lectures, newspaper columns from my NANA-syndicated weekly series, etc., prepared at various times but all currently valid, is added because it is felt that it is a real addition to the book and that they stand better on their own feet than integrated into the previous text.
Case History Examples: These nine "Case History Examples" seem particularly pertinent because sometimes illustrations of this sort supplement a text and bring out some of the points in a most vivid and understandable manner.
The chart on page 154 covers the principal swings of the Dow-Jones Industrial Average from 1929 to 1952, a period which adequately illustrates the points I wish to make.
Similar examples illustrating the same points can be picked for the period 1952-64. However, we have reproduced the case history examples exactly as in prior editions, and have added two recent ones.
The statistics have been largely drawn from The Value Line Investment Survey, one of the most useful reference books on leading stocks. Incidentally, this service has the advantage of being loose-leaf and continually kept up to date. The figures have been rounded out and are not intended to be precise. They are, however, correctly indicative of the general situation.
♦ 34 ♦
CASE HISTORY EXAMPLES
A BEARISH STOCK IN A BULL MARKET
Transitron Electronic Corporation
1962
1963
1964
Year I960 1961
Earnings $1.08 d$0.19 d$0.10 d$0.37 $0.12
Dividends nil nil nil nil nil
Value of 100
shares $6,000 $1,675 $625 $387.50 $462.50
d—deficit
Transiiron is just one of many examples that could be chosen to show that under modern conditions you do not need a wide open break in the general market such as occurred between
\ ( )1 ( ) and 1932 to sulTer enormous percentage losses. The
$6,000 figure chosen for the table represents the purchase of 100 shares at the highest price for 1960. The other figures represent the value of this stock at the lows for the following years.
Over the same period the Standard & Poor's average of 425 industrials was higher in 1964 than in 1960. The same company's average of seven leading electronics companies did not do as well as the general average, ending up 1964 something under its 1960 and 1961 highs, but of course showing nothing like the depreciation in Transitron.
The rise in Chrysler and the decline in American Motors (see page 158) is a striking example of how two stocks in the same industry can move in opposite directions. Many similar illustrations could be given both of industry groups moving in opposite directions and as illustrated here issues within the same group moving in opposite directions.
The advance in Chrysler reflected a change in management which greatly increased the sale of its cars and its earnings and dividend. On the other hand, American Motors, which had prospered mightily in the 1957-59 period, due to its success with compact cars, saw the demand shift and was adversely affected.
The value of 100 shares of Chrysler at the average price of 1959 was approximately $1,450. At the 1964 top the value was $6,500 and at the average for the year was about $5,000. One hundred shares of American Motors bought at the 1959 top would have cost $3,200 (average for the year was $20). By 1964 the average value was only about $1,500.
Years ago the stock market moved almost as a unit. Public ownership was restricted to a limited number of basic industries. The economy tended to move up or down.
Modern stock markets are different. There are times when credit conditions, interest rates and other over-all factors at least temporarily affect all stocks. But most of the time individual influences now play a very powerful part. One service lists its companies under more than 125 industry headings beginning with "Abrasive Manufacturers" and ending with "Util-
THE BATTLE FOR INVESTMENT SURVIVAL
STOCKS IN THE SAME INDUSTRY MAY MOVE IN OPPOSITE DIRECTIONS
Chrysler—American Motors
Year 1959 I960 1961 1962 1963 1964
Chrysler
Earnings $
Dividends .24
Val.of 100 shares . 1450
Amer. Mtrs.
Earnings 3.32
Dividends .39
Val.of 100 shares . 2000
il.02
.36
1300
2.63
1.13
2350
$0.44
.24
1150
1.28 1.18 1850
$1.89
.24
1350
1.83
.80
1500
$4.33
.42
3250
$5.46
.96
5000
1.99 1.38 1.00 1.15 1950 1500
(The above figures arc approximate. In some years the earnings vary because of internal or other adjustments. In some years the dividends are supplemented by stock dividends. Price and earnings are adjusted for two splits in the case of Chrysler Corp.)
ity—Telephone." They also list other companies under "Miscellaneous."
Not only are prosperity and adversity far from uniform but the popularity stock-marketwise of various groups that make for temporary overvaluation or neglect is constantly changing.
The record shows how important individual analysis has become to investment success.
DuPont is generally regarded as probably the best known growth stock and typical of the best type of equity investment as opposed to U.S.A. government bonds which are the best type of defensive investment. The chart and tabulations on page 160 like all in this series are general and approximate, intended more to reflect the situation than to be a precise statistical record. In this period, duPont's best year in earnings was 1950 with $6.59 a share, and its best year in dividends was 1950 with $5.35 paid. The actual high price for duPont was established in 1951. In general, the earnings of duPont reflect the prosperity of the country or perhaps something better than the prosperity of the country because of the favorable field in which duPont operates and its superlative management. Likewise, the fluctuations in the price of the stock reflect about the best that can be expected from a representative equity.
The record shows how much can be lost even in the best stock if bought at the wrong time and price. Shares of duPont which cost $5,800 at the top in 1929 were worth just a shade over $2,000 a couple of months later and only $550 at the bottom in 1932. Another way of looking at the matter is that a buyer at the top in 1929 had to wait till 1949, or 20 years later, before recovering his investment. The record since 1937 is far more stable, but even so, on two occasions, the stock dropped almost half its peak values.
It might be argued that anyone who bought a good stock like duPont merely had to hang on to come out all right. In real life, this is a different matter than in theory. The stock may recover after a period of years, but in practice emergencies come up and one has to sell. Also, the atmosphere around the bottom of
HOW MUCH CAN BE LOST EVEN IF THE BEST STOCK IS BOUGHT AT THE WRONG TIME AND PRICE
DuPont
(Adjusted to Present Capitalization)
Year 1929 1932 1936 1938 1939 1942 1946 1948 1952
Earnings $1.77 $0.45 $1.89 $0.94 $1.92 $1.27 $2.36 $3.28 *$4.60
Dividends $1.48 $0.69 $1.53 $0.81 $1.75 $1.06 $1.75 $2.44 *$3.55 Value of
100 shrs. $5,800 $550. $4,400 $2 300 $4.700 $2,600 $5,600 $4,100 $8,275
* Estimated.
declines is always a pessimistic one and, human nature being what it is, a person buying a stock at the wrong time is very apt to double his error and sell it at the wrong time.
Investment in equities, even the very best ones, must therefore be done with a great deal of understanding in order to be successful.
Douglas is a good example of how growth in a new industry
HOW GROWTH IN A NEW INDUSTRY CAN BE PROFITABLE MARKETWISE
Douglas Aircraft
(Adjusted to Present Capitalization)
T
1929 1932
Estimated.
can be profitable marketwise. In 1929, it sold at 23 and of course broke to very low levels in 1932 along with the rest of the market, but by 1935 it had recovered its 1929 level. Earnings in 1935 exceeded 1929 but it was really 1940 before they reflected their war growth at $9.03. It's interesting to note too that in 1941, earnings went to $15.15 but all through the year 1941, the stock ranged lower than during 1940, despite the very much higher earnings. By 1943, the market low was reached
but earnings were still $4.96 a share. The lowest earnings on the cycle were in 1947 when Douglas lost money.
The record here shows the importance of growth when not over-discounted in the market. It also shows that the highest prices for Douglas were reached at the time when war expectations were the highest and not at the time when earnings reached their peak. The Douglas 1947 low fairly well coincided with the low year in earnings for that period, and also with general market discouragement.
HOW LOSSES CAN OCCUR EVEN IN A SOLID ISSUE WITH A GROWTH TREND, IF TIMING IS BAD AND EXCESSIVE PREMIUMS ARE PAID FOR POPULARITY
International Nickel
(Adjusted to Present Capitalization)
1 itimated.
Postscript
163
An investor in International Nickel in 1937 bought a good stock at the wrong time and at the wrong price. (1) The general stock market declined and naturally pulled International Nickel down with it. However, the general market, measured by the
A FORMER BLUE CHIP GONE BAD
N. Y. Central
(Adjusted to Present Capitalization)
'Estimated.
Dow-Jones Industrials, was back to the 1937 level by early 1946, at which time Nickel had only recovered to 43. In 1952, Nickel had after 15 years failed to come back to its 1937 high, though many stocks and the Dow-Jones Industrials were much above 1937. One of the principal reasons is that Nickel was the
fashion in 1937. At that time, people bought Nickel to hedge against war and to hedge against inflation and because it could be sold in several different markets for Canadian dollars or pounds or francs. This over-enthusiasm resulted in bidding the stock up to a terrific premium. (2) Earnings declined. During the war years, the government dictated prices and of course taxes were higher. (3) The dividends declined. (4) In 1937, Nickel in the enthusiasm of that day, sold at 22 times earnings and to yield about 3*A%. In 1952 it sold at a price earnings ratio of about 10 times earnings and to yield 6 l A%. In other words, even though earnings and dividends were higher in 1952 than they were in 1937, Nickel sold lower, partly because of the elimination of the over-enthusiasm for the shares and partly because earnings in general sold for less in 1952 than they did in 1937 and higher yields were demanded.
The record shows how losses can occur even in solid issues with a growth trend, if timing is bad and excessive premiums are paid for popularity.
An investor in N.Y. Central in 1929 suffered from almost every conceivable cause of market losses. (1) The market and hence N.Y. Central was over-valued. In the 1929-32 decline the market and Central went from over to under-valuation. (2) The railroads lost markets to other transportation. (3) Population gains in the east started to fall to a slower pace than in west and south. (4) Earnings collapsed. (5) Dividends were passed. The record shows how costly bad timing could be and the rallies from 9 to 55 and 7 to 36 illustrate that even in a stock where the long pull tide has been out, great percentage gains can be made by correct timing.
Prior to 1929 New York Central was considered a premier blue chip investment stock with a safe dividend.
Technicolor is a good example of how romance can be overdone. In 1930, when the stock sold at 86V4, it represented little more than a tremendous capitalization of the idea of color movies. It sold at 61 times its 1930 earnings. A calculation at the time, based on Technicolor capturing 10098 of the film mar-
ROMANCE OVERDONE
Technicolor
* Estimated.
ket, at 1930 tax rates, promised little over $8 per share as an optimum net. A specialty situation of this kind, earning $8, would probably normally sell around 7 times earnings or 56. This just indicates how impossibly ridiculous the price of 86Vi really was. However, it is important to note that it was achieved. Short sellers sometimes think stocks can never get above what they imagine "real value" to be. As a matter of fact, almost every stock at some time or another is over-valued or under-valued, and generally once in its history either grossly over-valued or at an extreme bargain price. Technicolor was over-valued at $40, $50, $60, $70, etc., but that did not prevent it from selling at 86 ! /2.
Earnings practically evaporated in 1931, and in 1932, 1933 and 1934 there were deficits. The working capital in 1930, when the stock reached its high, was less than three quarters of a million dollars. Contrast this situation with the real worth when the selling price was $6 in 1941. In that year, the company had demonstrated its success, had a working capital of $3Vi million, and actually earned $1.05 per share and paid out $1.00. It was therefore available at 6 times earnings. While the next few years were lean ones, by 1949 Technicolor was earning $2.56 a share and paying $2.
The record shows how very great a part psychological influences can play in market valuations. It also shows that much greater value is often placed on expectations than on reality. Stocks ordinarily make their highs at the moment that the greatest number of people visualize the greatest possible value, and not necessarily at the moment when the highest earnings or highest dividends or highest values are actually achieved.
Warner Bros, sold between $1 and $3 during 1940, 1941 and 1942. An investor in Warner in those years benefited from almost every conceivable helpful factor. (1) The general market rose. (2) Warner's earnings went up. (3) Warner went from a non-dividend paying basis to a dividend paying basis. (4) Warner's financial position improved and the company retired debt and preferred stock. (5) Motion picture stocks were very unpopular around the time of World War II, thus making them very cheap. Investors incorrectly thought that foreign markets would be lost. As time went on, this view proved completely incorrect and motion picture stocks reached the peak of popularity in 1946 when a combination of unusually large grosses and a tax reduction made for record earnings. Since that time, they have lost in popularity because of the threat of television and they've also declined counter to the general market because of declining earnings and dividends.
I he record shows how very profitable a stoek commitment cm he when all factors unite in one's favor.
Postscript
167
EVERYTHING WENT RIGHT
Warner Bros.
(Adjusted to Present Capitalization)
Estimated.
feel your stock has reached a final maturity or a plateau of several years' probable duration. Then it is wise to use the lesser amount of proceeds from your sale to reinvest in another direction where you feel things are on the move.
Offset Uncertainty
A good reason, and one not ordinarily given much weight, is to offset future uncertainty by cashing in on some profits by degrees. This way you get an average of variables and imponderables such as errors in judgment, unexpected news, changes in the tax laws, etc.
You may be lucky enough to have a tremendous profit in a stock that still has a bright future and is still reasonably valued. You need some cash but don't want to pay a tax or reduce the size of your investment. The thing to do here is to borrow. This way you can raise money tax-free. The interest you pay is tax-deductible.
Now suppose you own stock at a loss. To the extent that you can deduct it, selling gives you increased capital to try and recoup. You can invest the proceeds plus the tax savings. If you are successful in finding a stock that recovers, a new tax liability will build as it advances. You really have not "saved" any tax. You have postponed it and had the use of tax money interest-free until such time as you realized a profit.
Reluctant Loss Takers
Most investors are reluctant to take a loss. If you are spurred to act for supposed "tax saving" reasons, this will have some favorable side effects. As soon as your stock is sold you are free to stand aside and take an unbiased view of how best to recover. Chances are you will buy some other issue with improved prospects once you are free of your losing stock.
Before you do anything, get a folder on the tax rules from your banker or broker. It is important to know why losses should be taken, if possible, in six months or less and gains longer than six months. There are times when losses should be
by doing, which, after all, is the best way to learn. The difference between theory and practice is very wide.
Investment Sample
For example, if you have $10,000 to invest you can buy an odd lot amounting to about $ 1,000 each of such institutional favorites as International Business Machines, Texaco, General Motors, American Telephone, duPont, General Electric, International Nickel and Eastman Kodak. This would leave about $2,000 to keep in short-term U.S. Treasury bills to use in an emergency, or in case the market declines later and you want to buy more stock.
A more experienced odd-lot investor might take some of the remaining $2,000 to buy $500 each of four less seasoned, more speculative issues.
Odd-lot orders are placed with your New York Stock Exchange member broker. They cost more to fill than round lots, which is understandable. Everything costs more in retail than wholesale; costs more in small packages than in large.
Higher Commission
As an example, the commission on the purchase of a round lot of 100 shares of General Motors at $80 would be $47, or 0.6 per cent of the purchase price. Buying an odd lot of 25 shares would involve paying the "odd-lot differential," or 80V4 plus the odd-lot commission of $25.06, or 1.6 per cent. Doing it yourself through odd lots saves sales, management, custody and other costs passed on to you when buying investment trusts.
There has been a myth in the market for many years that "odd-lot investors are always wrong." This is simply not true. Odd-lot investors invariably buy more than they sell. As good stocks have gone up over the years, those who have held on to them have profited.
Rarely is one able to use Successfully the totals of reported ockl-lot transactions as a yardstick for market forecasting. The figures must be looked at in several different ways and earefully
Maximum Income
She is sure to be asked to outline her objectives. The temptation is strong to reply, "Maximum income." This might imperil the safety she needs and cost her more in the loss of potential gain than the increased income justifies.
A woman investor's first need is quality. She should buy the really good stocks. In good times these high-grade issues should show her a net result of profit, plus income, less tax, that could constitute a maximum gain. In bad times the stocks could give her relative peace of mind.
If I were advising a woman client I would discuss the following:
How will you live? Take for your spendable income an amount equal to IV2 per cent of the net realizable value of your security fund each quarter. (Taxes are paid out of capital— dividends are added to it.)
You will be living partly on dividends, sometimes on profits or appreciation, sometimes on capital.
In the long run, if you receive good advice and your stocks are top quality, you will come out satisfactorily.
There is enough protection in taking the equivalent of 6 per cent annually out of your fund to care for even several unlikely bad years in a row. As the equity shrinks so will the 6 per cent withdrawn from it.
Historically I think the indication is you will do better than had you been a miser with your money or purchased fixed-dollar investments, or had you aimed for income only.
But remember, life is a succession of cycles. Day and night. Hot and cold. Good times and bad. High prices and low. Dividends increased and dividends cut. So don't expect your investments to be the exception to the rule.
Sell Out the Bottom
An essential procedure for all investors regardless of sex is sonic form of regular methodical supervision. I don't like to lay down any hard-and-fast rules, because they need to be adapted
to circumstances. A point of departure might be to sell out the bottom 10 per cent of your holdings once a year and replace with the best you can find at the time. Something like this done annually should help to keep your list in tune with the times and to weed out deadwood.
This is a plan to try in order to stay safe, not to get rich quick.
There are women and women. I have seen my share of their accounts. They tend to be more emotional than practical. Emotions have no place in investment decisions. Trouble is, we all have them to a greater or lesser degree. If the woman investor demonstrates fear or greed this might be recognized in the advice given, the stocks selected, and the policies pursued. A good broker can help with almost anything but cunning. Heaven help a cunning investor.
Yet I have seen two or three women over the years with a special something that makes for success in the markets. Knowledge? Instinct? Flair? Connections? It makes no difference. They should be given their head and encouraged to go on their own. It never pays to argue with success, whatever the reasons.
Women own most of the stocks and will own more.
promising new product, an expected improvement in the market's valuation of earnings? In any given case you will find that one factor will almost certainly be more important than all the rest put together.
Writing it down will help you estimate what you expect to make. It is important that this be worthwhile.
Of course, you will want to decide how much you can afford to lose. There will be a level at which you will decide that things have not worked out and where you will sell. Your risk is the difference between your cost and this sell point; it ought to be substantially less than your hopes for profit. You certainly want to feel that the odds as you see them are in your favor.
Much More Difficult
All this self-interrogation will help you immeasurably in the much more difficult decision: when to close a commitment.
When you open a commitment, whether it is a purchase or a short sale, you are, so to speak, on your home ground. Unless everything suits you, you don't play. But when you are called upon to close a commitment, then you have to make decisions, whether you see the answer clearly or not. The latter situation is like being stuck on a railway crossing with the train approaching. You don't know what to do—but you have to do something. Go backward, go forward—or jump out.
If you know clearly why you bought a stock it will help you to know when to sell it. The major factor which you recognized when you bought a security will either work out or not work out. Once you can say definitely that it has worked or not worked, the security should be sold.
One of the greatest causes of loss in security transactions is to open a commitment for a particular reason, and then fail to close it when the reason proves to be invalid.
Write it down—and you will be less likely to find yourself making irrelevant excuses for holding a security long after it should have been sold. Better still, a stock well bought is far more than half the battle.
cases stockholders are paid off better with their company dead than alive.
Correct judgment of management policy can only come from a full understanding of the problems involved. For example, since 1954, New York Central has invested $453 million to take advantage of the fast changes in transportation technology. The book value of the property is over \ l A billion. Yet earnings in 1963 were only $7 million, and the year before it showed a loss of almost $4 million. This is a long way from realizing much, even for a railroad.
Promised Savings
However, if you dig deeper, New York Central would be another New Haven today if Mr. Perlman, who became president in June 1954, did not follow this course of action. His investment of $453 million over the years promised a potential savings (or a return) of over $300 million, if outside influences beyond the railroad's control had not interfered. Wage increases, employee benefits, retirement-tax increases, excess crew laws in certain states, etc., all contributed to nullify the major benefits planned. The investment was needed to row upstream successfully and keep the Central's head above water.
It will pay the investor well to look beyond the superficialities of figures showing totals put back into business by management. Consideration should be given to the past record. How have plowback expenditures actually turned out?
There is no hard-and-fast rule. Sears, Roebuck stockholders profited enormously by management spending. Montgomery Ward stockholders suffered through management hoarding. Timing is important. Many unwise investments were made by corporate management in 1929. Some very wise ones were made in the early thirties.
The point is that here is an often-overlooked factor which you should include in your analysis of stocks to buy.
The provision leaving income to a widow and, at her death, the capital to children, can be a source of trouble. The widow wants high-income stocks—the children lower-paying growth issues. One possible solution is to avoid precise provisions and leave it to the trustee to distribute income and invade principal if necessary. This approach would usually provide adequately for the widow and also allow the trustee to invest in growth issues, thus satisfying the children.
Third Party
No matter how carefully a document is drawn, it is always worthwhile to have a competent third party read over the completed document.
I learned of a trust agreement making the son trustee for his mother. It also provided for him to inherit the residual principal of the trust upon her death. This instrument was drawn by a topflight nationally known law firm. Fortunately, a bank was named as successor trustee in the event of the death of the son. Before the papers were signed, the bank was asked to approve its role. The bank's lawyer found a flaw in the agreement. The son owed an immediate gift tax on capital he might never receive.
The practice of writing your own will in your own handwriting in your own way is almost certain to result in failure to carry out your wishes. Such possible provisions as the little known and not so well understood marital-deduction clause would probably escape the writer of his own will.
Never underestimate the abilities of your wife and children after you are gone. You may never have given them a chance. The instinct of self-preservation is very strong. Many a wife and child who have not demonstrated business ability have turned into good money managers when given the chance.
As a practical matter, it will pay you to look at the lists of "new highs" and "new lows." If a majority of the stocks you own are making new highs you have the right issues for a current move. If they are making new lows it is time to ask your broker or investment adviser why. This policy can often save you money by cutting losses or promoting profitable exchanges.
Check on stocks that make new highs and on quiet stocks that begin to develop plus signs and higher volume. This can help you find new and profitable shares to buy.
One simple way of doing it is to run your finger down the daily stock tables and note the names of the shares that trade more than 10,000 or advance more than a point. If you do this daily you will almost certainly note some developing strength.
Wheat from Chaff
All of these issues won't continue going up. It will be up to you and your broker and adviser to separate the wheat from the chaff. The point is that no important advance or decline can occur without casting its shadow ahead with increased volume and significant plus or minus signs.
One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages. The weakest issues are likely to be the ones where weakness shows up individually before it becomes general.
The day is always bound to come when the last and final high or low is made. This is the noontime or midnight of the market. It has to occur. The early buyer or early seller will not be caught. The investor who is late will get a warning by failure of the trend that attracted him to continue.
Despite the hazards, following prices is still the first factor to investment success.
good management in echelon depth which can survive the retirement or death of its chief executive?
One aspect of management worth your noting is the extent to which the officers own their own shares. Broadly speaking, it is advantageous for the officers to have a stake in ownership. It makes a difference whether they own the stock because they want it or because they are stuck with it.
You should consider whether they acquired it through inheritance, bought it on option, or bought it in the open market. Likewise, where possible, consider the purchase date and the price paid. The Securities and Exchange Commission releases regular reports on officer transactions.
Close Watch Pays Off
Of the various ways of making money in securities, I know no better way than through a close watch on management. Changes I particularly refer to are those where companies have been in difficulty, their stocks depressed, and general dissatisfaction expressed—and where a new management comes in and invariably begins by sweeping out the accounting cobwebs. Everything is marked down or written off so that the new management is not held accountable for the mistakes of the old. Very often dividends which were imprudently paid are cut or passed. Thus an investor at this juncture often gets in at the bottom or the beginning of a new cycle.
Attempting to evaluate management, even though you can't get all the answers, is worth all the effort it entails.
for those risks. Yet this can be a testing period to see just how well you are adapted to money-making. You can't risk everything because your mistakes are apt to be frequent and costly, and you have to leave some reserve for a comeback.
The second age period, 30 to 50, is your real money-making time. If you are hoping to make a fortune, this is the period for it. This is the time to borrow and look for leverage and try to get other people's money working for you.
If you are between 50 and 65 you should be well set in your investment patterns with some measure of success. You are probably eager to hold on to what you have made. Making more profit has less meaning now than in prior years.
It Keeps Changing
If you are like most people in this age group, you are living somewhat in the past and thinking that your investment experience is bound to keep repeating—when actually it is changing. It is difficult for you to change with it.
If you are retired, you may want to keep occupied with your investments—or you may need to engage someone to do it for you. You could do this by buying an investment trust or going to the investment-management department of a bank or to an investment counselor. Either way, you will have peace of mind only if you do not become a back-seat driver, and instead resolve to be satisfied with maintaining an equilibrium in your portfolio.
Don't look for spectacular results at retirement age; be resigned, rather, to receiving average results from whoever manages your investments. Look for steady, adequate income and conservative transactions designed to keep the portfolio from slipping into the loss column.
While I don't believe in ignoring such changes in your financial status, I certainly advise against counting them wholly as income (if they are on the plus side).
My inclination is to take an arbitrary 6 per cent of their total into my income estimate. To illustrate: If your net worth increases $10,000 in a year I think you can add $600 to your income estimate. If it decreases by the same amount, be sure to deduct the $600 as well.
A simple, practical way of keeping accounts and dividing your budget funds is to have a separate bank account for your "must" items and contingency reserve and another for your current expenses. Naturally your working capital investment account will be further segregated.
"Must" Expenses
Now you will come up with your estimated income for the year ahead and your "must" expenses. You have the difference to divide among rent, food, education, transportation, amusement, clothing and everything else.
I did not list "savings" because I prefer to label that part of your budget your "working capital" for appreciation. If you feel you can win in life, invest to build your fortune. If you feel you cannot—save for protection.
Here is where your personal aims and desires—your will to sacrifice or not to sacrifice—come in. Here is where some of us will budget for a better home or car—and lesser "working capital," or the reverse. The worth of your budget is that you decide what you want, and how able you are to get it. Budgeting will bring your plans into focus.
I think the pattern that works best is to be frugal while young and build your "working capital." Spend in the prime of life. Pull in your horns again upon retirement. This program fits your capacity to enjoy and your capacity to afford as closely as most of us can.
And if you can, keep your eyes looking up.
There are going to be times when you cannot determine any visible reasons for a decline. There will be times when some explanation for the fall is available, but the lower price will seem to have taken it into account.
There is no standard answer to such situations. Trends in prices, trends in the news, trends in value—all can and do change. Each situation has to be judged on its own, and in relation to your other holdings.
However, if I were pushed into a general rule, I would say that I think you will be better off liquidating when in doubt. I might express this another way by saying that if the situation isn't strong enough to suggest a fresh purchase, then you certainly should liquidate. You may be "whipsawed" now and then but in the long run it will pay out.
Should You "Average"?
Buying more of something that has started out badly is known as "averaging." I would say that most times this will prove an unprofitable thing to do.
The important attitude is to attempt to develop objectivity. Try to forget you own the stock in question. Try to forget you have a loss. Look at it as if it were a stranger and you were thinking of whether it rated an initial purchase. If so, maybe you are justified in holding. If not, take your loss.
There is a second factor here you are apt to overlook. That is what you plan to do with the proceeds from the sale of an unsatisfactory holding. Sticking with a declining stock can cost you double: first, if it declines further; second, if it keeps you from buying another share that is advancing.
Putting the spotlight on your failures is one of the surest ways of achieving over-all investment success.
has always recovered to reach new heights. From that point of view, I have no quarrel with the maxim.
The trouble is in applying it. Most people who use it do so incorrectly, referring to some segment of a given situation: maybe their personal business, or a particular stock they have, or some industry.
An industry can be in a decline, heading for difficulties, even going into bankruptcy. Therefore, to hang on blindly and say, "Never sell America short," is foolish, because America can go right on growing and prospering whether or not this particular business passes out of the picture.
So be sure when you use this expression to think of it as regards our economy, our well-being and our nation as a whole, and not as an argument to stay with a situation that perhaps you should abandon.
And then there is the widely held view that "Preferred stocks are better than common." The word "preferred" in everyday life always means something that is better. But in investment parlance, preferred stocks are not really better than common stocks. They rank ahead of common in some ways but are far less desirable in others.
The common stock of a sound company that is moving ahead is likely to be far more attractive than the preferred of a weak company that is slipping.
Look into each issue individually. There are exceptions, and these are mostly preferreds with an attractive conversion privilege, or those selling at a discount and coming out of trouble. But in general, don't let yourself be misled.
Many factors are responsible. It would seem that an unfavorable change in the outlook for their industries was the major cause.
The greatest changes were in transportation companies. It is asking too much to profit from selling horses and buggies in a gasoline age.
It boils down to the always prime factor of management. It takes superior management to adapt to change. And it takes superior management to build worthy successors to follow in their footsteps.
The National City letter concludes that to achieve success and hold it corporations must secure a primary position in growing markets. They must be adaptable enough to shift into new fields that open up and to fill new needs.
It is up to you as an investor to watch the progress of your companies and switch your investments if your managements fail to keep up with the changing times.
None Since '96
The same proof of the inexorable nature of change can be shown in other ways. Earlier a Morgan Guaranty survey compared the stocks that have been part of the Dow Averages since 1896. Continual evolution, shifting investor preferences, and the alterations in the actual composition of business activity have resulted in not a single issue remaining on the list for the entire 68-year period. Only American Tobacco and General Electric are on the 1912 and 1964 list, but both were on and off several times.
One of the least reliable guides to investing is popularity. The transportation industry again contributes many once-popular investments that have vanished or have all but done so. The carnage in streetcar lines and other utilities has been enormous. Likewise in early automobile leaders.
Investors should make a conscious effort to do some switching in their portfolios. I think at a minimum they could switch 10 per cent of a list of diversified investments annually. If you
The same mutual fund points out that this kind of thinking gets investors to forget long-term objectives, to overspeculate and overtrade and to take poor advice. This fosters a tendency to overcommit funds and to forget that a high level of stock prices often already reflects good news.
Such a change in policy may produce losses rather than gains, can undermine the investment position by increasing risks just when they may be at their greatest and dissipate buying power at what might be the top of the market, and it generally leaves a portfolio a hodgpodge.
Here are the basic rules which this investment-advising firm feels will help to keep your house in order under today's conditions :
Have a firm foundation of the strongest and best common stocks of companies which are moving ahead and which have shown an ability to do well under all sorts of conditions.
Include some reserves as protection against less favorable times.
Stick steadfastly to your long-term investment plan, not modified by the fears or exuberance of the moment.
The application of these comments depends on a reasonably correct judgment as to where we stand in a bull market. Bull markets are not generally recognized until they have run some distance. The great danger is that you are apt to be very cautious in the early stages and then throw caution to the wind when the market keeps going higher and your original opinion seems to be wrong. It is well to remember that most major moves end in what later proves to be considerable over-evaluation. It is at just such times that these restraints are most valuable to an investor.
When should you seek short-term profits? At any time you feel the market situation is favorable.
You have heard the old saying, "Make hay while the sun shines." It certainly is applicable to the market. You will find it easier to make money in a sunny market than in a stormy one. It is foolish to let an opportunity slip from your grasp because you have to share too much of your potential gain with Uncle Sam.
It may not even work out that way. The stock you buy for a trading turn can occasionally improve in value and end up as a profitable long-term investment. Thus, the rule of letting investment principles guide you can work in reverse and take you into a lower tax bracket.
Profits are always worth having, in any case. Suppose you are fortunate enough to realize a short-term profit early in the year. Don't think of it purely as a tax ticket. It can open other doors.
As the year progresses you may find a very unusual purchase for important potential long-pull gains. You can now afford to risk a larger position than otherwise because of the cash backlog created by your short-term profit. If you should be wrong and are forced to take a loss you can offset some of the loss with the previous profit and thus get Uncle Sam to share the loss with you.
You should never hesitate to take a profit, regardless of tax, if you feel waiting could endanger your gain. A profit, large or small, is always worth having.
its most popular use. In theory the idea is a good one. Deciding at time of purchase, or as you go along, to automatically cut a loss, prevent one, or cinch a profit, is good discipline.
Likewise, a stop order at a supposedly vital "breakthrough" point gets you in, even though your broker could not reach you at the time. He has your order and he, or the specialist, is on hand to carry it out.
The rub comes from two factors. The stop-loss idea and the chart breakthrough idea have grown too popular. A congestion of similar orders touched off at one time can overaccentuate the price movement of a stock. This can make for a very unsatisfactory transaction when your order is finally filled. In fact, to protect investors, the exchanges have had to prohibit stop orders temporarily on certain volatile stocks.
The second factor is that widespread belief in a certain point on a chart as bullish or bearish greatly reduces the possibility that the concept will turn out to be right. More and more stocks give what traders label as "false" indications. This can result in costly errors if you are a slavish follower of chart theories. The "falsity" of the indication is not known until after you sell your stock and see it turn about and advance—or after you buy it, and see the move fail to develop and turn into a fall instead.
Watch the Crowd
To safely and usefully employ stop order techniques you must give full weight to what the crowd is probably doing. There can be no hard-and-fast rule that always applies.
I suggest considering a "second penetration" if you are uncertain whether a move is valid. After the stops are filled, you can observe whether the movement promises to continue or reverse. This means you might be saved a false move. On the other hand, you will pay more or receive less for the sake of being more certain of your conclusions.
Another way is to try and prejudge a move and act before the key price is breached. You can then stay with your position if it
been based the company's present policy that it will not pay cash dividends in the foreseeable future.
"Firstly, Coastal States is still growing, and we are constantly calling upon outside financial resources. If we pay out cash, we have to make up for it by borrowings and that costs the stockholders an interest expense. The payment of cash dividends at this time could actually have the effect of restricting our growth.
"Secondly, by reinvesting net income back into the business, we realize a comparatively high return.
Borrowing Position Improved
"Thirdly, by converting earnings to equity, we enlarge our borrowing position. For every dollar reinvested, there is the possibility that we might qualify for as much as another $3 in borrowed funds, subject of course to having the necessary earnings and meeting the requirements and tests of our various indentures. In other words, every dollar that would be taken out of the business in the form of cash dividends might cost the company three times as much in capital funds needed for future growth."
Mr. Wyatt's reasons in his case are thoroughly justified because the Coastal record of investing its money has been outstanding. The stock was first publicly traded over the counter at the equivalent of $1.67 per share. It has sold above $40 in 1963. Thus, stockholders have gained handsomely by leaving earnings to compound with the company rather than having a part paid out to them for division between their own use and taxes.
What you will have to consider the most in buying non-dividend-paying stocks is whether the company is in an industry and of a type where management can do more with your money than you can. And of course whether the particular management in question has the ability.
legends—and also its fallacies, myths and misconceptions.
I think it is most important for you to try and separate the real from the unreal, and to examine them—particularly the fallacies—one by one. There are almost two dozen of them that have dangerously wide currency.
One old saw I am sure you have heard many times is that "Stocks recover if held long enough."
The woods are full of examples of stocks of investment grade that have never "come back." Some have vanished entirely.
"Come Back" Fallacy
Stocks such as New York Central were prime investments prior to 1929; so was Consolidated Edison; so was Western Union. There was a time when the New Haven Railroad Stock was the darling of every New England widow and orphan. New Haven has never come back; Central, Western Union, Consolidated Edison are all selling at a fraction of the prices they once commanded.
It should be realized that even when stocks do come back, the original investor benefits very little if it takes the stocks twenty to thirty years to do so. During that period, his life, needs and desires have changed. The value of money has changed. In the meantime, other opportunities have slipped by.
So it is much better to accept a loss, if you can, while it is still moderate—say 10 per cent or so. But if the stock really runs away from you, usually it is better to take a substantial loss and start off anew than it is to be tied hopelessly to something which you wouldn't buy if you had the cash.
Short-Term Investments
Someone at some time probably told you that "short-term trading is speculating." I think the idea is fallacious. By "short-term trading" I mean trading from hour to hour or from day to day and occasionally from week to week. I am not thinking, from the tax viewpoint, of less than six months; I am thinking of trading over very brief periods of time.
much time went by, and the original investors either dropped out, were forced out, or their equity was greatly diluted. Promotion costs alone to finance something with no record of earnings are generally excessive, introducing much "water" into the capitalization. This is a form of investment that involves the greatest pitfalls and highest risks to the investor.
The odds are greatly improved when this is done by an established publicly owned company of good reputation dealt in on the New York Stock Exchange. In such a case funds are either available or can be secured at normal costs. A portion of the probable initial operating loss can be charged off against earnings. Here we find success as well as failure, but the odds are good. Once in a while an enormous success will result.
New products, new designs and new services appeal to the imagination. Hence they are sometimes overemphasized by management or brokers.
This is especially true of something exotic or romantic. The first question to ask if you are told to buy a stock because of something new is how much contribution to nearby earnings is expected. Very often you will find that it will be an item of expense rather than profit for some years at best. And in other cases you might discover the nearby maximum potential is a very small percentage of the total earnings of a big company.
There are exceptions. A new drug with a high profit margin and protected by patents can be an important earnings factor. There are companies whose products are necessarily always being changed, and here correct judgment can pay off. This would apply to automobile models, motion pictures and television programs, etc. The replacement of an established product by an improved product of the same type can have an early impact on profits. Success here is more frequent.
As in every other investment situation, market action never exactly coincides with realization. The average stock goes up on great expectations. Very often the rise is excessive. It frequently occurs well ahead of actualities. Sometimes the whole expectation is never realized. The new product fails to take on or produce a profit.
what on what investors considered the good news. His reasoning was that if he lost then they would go down faster and further. He was right, and it was the latter that happened.
President Kennedy's denouncement of the steel price advance in April 1962 came at a time when the market was very weak from overspeculation. The decline was immediate and precipitous. Actually, the top had really occurred late in 1961. Stocks would have gone down anyway.
The assassination of President Kennedy in November 1963 merely interrupted an advance that had been gaining momentum since the summer of 1962. The market was in a strong position. The memory of the 1962 decline was still fresh in investors' minds. Despite the fact that the industrial average was at a new high a few weeks before the Kennedy assassination, the internal technical position was strong. There was confidence in Vice President Johnson. Once it became evident that the assassination was an isolated one, the market resumed its upward path.
The news of Pearl Harbor came at a time when market prices were low and the technical situation was strong. Prices declined only slightly and then rallied. They dragged lower for a few months as the war news was unfavorable, but then turned up. By June, when the heavy Japanese loss occurred at Midway, the market was headed for several years of improvement.
If you look back at important turning points, it is very difficult to correlate them with the news. The 1929 top was established on September 3. There was no particular news at that moment. There was plenty of warning in many news items in 1928 and earlier in 1929. The rediscount rate was raised three times in 1928 and finally reached 6 per cent in August of 1929. The Federal Reserve had warned on speculation in February. Secretary Mellon had advised buying bonds in March. Call money cost 12 to 20 per cent in that month. The 6 per cent Federal Reserve rediscount rate was actually recommended in May.
This is the more typical response to news. It takes a long time generally to sink in and be effective. Most of the time it is better to wait and assess the situation. If your investment position is
purchasing power. You cannot simply pay a premium and receive in return assurance of getting back your savings fully preserved from the inroads of inflation and taxation.
Investors who put their money into savings banks, savings and loan companies, mortgages and the like not only expect to keep the value of their savings intact but they want a rental (interest) for the use of their money at the same time.
Investors who buy common stocks or real estate expect dividends or rental income and a capital gain or profit as well.
This is an optimistic point of view, but I think it is unrealistic. Most people of experience would probably be happy to settle for getting back the same after-tax purchasing power that they initially put in.
Inflationary Hazard
Those who make fixed-dollar investments or bury their money in the ground have some protection against deflation if liquidity, collateral values and credit are sound. They suffer in the inflationary world to which we have become accustomed.
Those who invest in equities, which means in stocks, real estate, private businesses, etc., don't suffer as much during inflation as the fixed-dollar class. The gains they sometimes seem to realize are seldom lasting or real. An individual's ability to work at a profession or on a job has an equity value. His compensation tends to increase with rising prices but is clipped by the same rising prices and by taxation.
Your best weapons against the forces that tend to clip your fortune are knowledge and experience. Realization of the conditions that exist should lead you to learn more about them. This can be done by reading and talking to those who you feel know more about it than you do.
The acid test is to learn to be a knowing participant in the game of getting ahead of the other fellow. When you feel you are ready to start guiding your own destiny, do it on a small scale and on an experimental basis.
You are going to find it more difficult than you expect, but also more rewarding.
salaries, bonus plans and pensions fair? It is quite proper that investors do concern themselves with such vital factors bearing on the success of their stock investment.
However, there is a tendency to look with favor on low paid management and with disfavor on the management that seems to get the most liberal financial treatment. This is in my opinion both a short-sighted and incorrect point of view and it is just because so much is written against corporate management and so little for them that I write this.
The important fact for the investor is that his corporations' compensation policies all the way down the line attract and hold the best men. A company is only as good as the men who run it and work for it and who will rise to manage it in the future.
Today our tax laws are such that old-fashioned savings are out of the picture. Both labor and management need, under modern political philosophies, provision for the future in pensions and other similar plans. Each corporation is in competition not only with other corporations but with private business to attract and hold the best executive manpower. Thus, there can be no rule about it—each case must be judged by the investor not on whether management pay is high or low but from the standpoint of what the company is getting at the price paid. Naturally, the size of the business is a factor, too. But generally, the best is cheapest in the end.
To cite one example, no price was too high to have paid Walter P. Chrysler to go to work for the obscure and failing Maxwell-Chalmers Corporation—and build it up into one of the big three motor makers. No low figure, paid the managements of the smaller independents that at the same time fell by the wayside, could possibly have been a bargain.
The same might be said of management ownership. By and large, it's preferable to have the managers of a company own a major stake in it. However, it doesn't follow that the corporations with the highest percentage of ownership management are the most profitable to own by any means. Each one has to be judged on its own merits. If the officers and directors of a
company are recent buyers and if they use a high percentage of their own funds, then the situation is most favorable.
The days of secrecy and a smug attitude are over and those in high places who don't realize it will find that investors will shun their shares and thus cause them to sell at lower price earnings ratios and on a higher yield basis. In time, they will find themselves in even more tangible hot water.
Stockholders' concern with the selection and compensation of corporate management should therefore be primarily concerned with securing the best possible men to get the most out of the business rather than the cheapest. In most listed corporations the total top management salaries, etc. is at worst a very small percentage of net income; but the mistakes of corporate officers hired purely on a low price basis can be a very high percentage of net income or even eliminate any net income at all.
Eastman Kodak, Westinghouse Electric, or a theoretical group of stocks.
One of these older tabulations, for example, considers Westinghouse Electric from 1937 to 1954. According to this, $1,000 invested annually, or $18,000 in all, would show a value at the end of the period of $41,580. The authors calculate the appreciation including dividends at $23,580 or 131% over cost price. This is something like an average of 7% to 8% gain a year.
The fallacy in this line of reasoning is first that it looks backwards and not forwards. For example, Westinghouse sold as high as 42 in 1937 and declined to 15% by 1942. In all these 6 years the fund must have been steadily sinking and would offer very poor results for any one who had to liquidate. It seems to me that the hazards were great, that the plan could be brought to an end prematurely or incompletely. Usually, when stocks are low, they are low because general conditions create a lack of funds for investment. In order to make these tabulations work it is, of course, essential to be a buyer at the low points. This is just sure to be when people are having trouble making both ends meet in their personal budgets. Some of these plans show up very well but they include large amounts of stock bought at the panic levels of 1932. This was a time when people were not paying their rent or their mortgage interest, and when we had enforced moratoriums. It is wholly illogical to suppose that the average person would have the means to keep up his periodic savings.
There is also the matter of faith. It is human nature to feel optimistic and confident when prices go up. When prices go down people begin to question whether they were correct in buying in the first place. For instance, in Westinghouse, earnings in 1946 during the period of this theoretical calculation totalled only 65^ a share. It would not be hard and only human to feel under the circumstances that it would be wise to stop the plan and cease throwing good money after what looked like bad, even if one had the money in the first place.
Looking forward, which no one could do when the suggestion was made, Westinghouse did a lot better until 1960. In that
year, it sold above 60. Three years later in 1962 it was selling under 30. As this is written it is showing some recovery. Hindsight is one thing and foresight is another.
These tabulations showing what could have been made always select stocks and periods which work out well. But, for example, back before the 1929 crash an investor looking forward might have selected such blue chips of that day as New York Central, Western Union, Consolidated Edison. All three of these looked fine at the time and would have yielded impressive results in the period ending in 1929. However, in the period following 1929 all of these three issues and a very great many others completely and unfavorably changed their status.
New York Central earned over $16 a share in 1929, paid over $8 and sold above $250. In 1953, 24 years later, it earned $5, paid $1 and sold at an average price of $21. This is typical of what happened to many formerly fashionable stocks. There is absolutely no insurance that it won't happen in the future to many fashionable blue chips of today.
I very strongly advise anyone, who, against the opinions expressed here, embarks on such a program that they select a listed investment trust for their proposed periodic purchase. If you select a good one, enough shifts will be automatically made in the trust portfolio to gear any investment more or less into the average rise and fall of the market and the great hazards of an unfortunate selection will be eliminated.
The hazard of bad timing and inability to stick with a plan will, of course, still exist.
Literature of the Street, for a long time now, is full of opinions that the stock market is going up because it always has. We arc told we might have to wait 10, 20 or even 50 years but we arc assured that it is going up, surely as we live that long. Another popular compilation supposes the investment of SI,000 in each of 92 stocks from January 15, 1937 to January 15. 1950. I he gain here is theoretically calculated at 12.2% compound interest. This is lumping market profits and dividend
unts together. Thii is uncerelj believed by its authors to
i objective test. I he\ have chosen a period when the Dow-
Jones Industrial Averages were very close to the same level at the start and finish. And, they have selected the 92 stocks on a mechanical basis of all the shares that traded a million or more shares in 1936. It came to 27 different industries.
However, the whole idea is purely theoretical and completely impractical. Who has $92,000 a year to invest, through good times and bad? Who can reinvest all dividends and pay living costs and taxes out of other funds? Who can stick to the plan through thick and thin when things look blue? Who is going to have such a placid life that no emergencies will occur?
A genuine investor who had perhaps $500 a year to invest would come up against terrific commission and odd lot costs that are not figured in the tabulation above. As in the other tables, income tax is not figured either. No one can buy the "stock market" or the "averages." They have to select individual stocks.
Aside from the foregoing considerations a completely neglected fact is the changing purchasing power of the dollar over such a long period of time. This occurs in more ways than one. It might just be a plain decrease through inflation or a plain increase through deflation. But it can also be political or influenced by laws. Rationing, for example, limits the value of a dollar. Currency restrictions accomplish the same purpose. Extraordinary large sales taxes, prohibitive tariffs or tiny import quotas all affect purchasing power. It has been aptly said that a bird in a hand is worth two in the bush. Money might be very much more spendable at the time it is saved than at the end of a long 15 or 25 year plan. The value of money changes in an individual and personal way. We spend it one way and enjoy it differently at age 35 than at age 55. All this suggests very careful thought before committing oneself to some inflexible formula on the argument that if you wait long enough, you'll come out all right. I certainly would not want to decide at the point of departure what I was going to do all the way, come what may. I feel that investing is a very inexact science or no science at all. I think it can only be successfully done by feeling your way along, cutting short losses, concentrating on the
profitable situations and certainly, above all, avoiding being locked into an inflexible long-term program. Averaging, to me, most of the time means throwing good money after bad. Pyramiding which is just the reverse is far more appealing. It always pays to follow your successes and rarely pays to persist with your reverses.
Back in August 1929 John J. Raskob said "No one can become rich merely by saving. Mere saving is closely akin to the socialist policy of dividing and, likewise, runs up against the same objection that there's not enough around to save." I must agree with that view completely. However, surviving has to be done by the use of intelligence, not through expecting miracles.
The whole subject of the record of common stocks is being completely and exhaustively studied by the "Center for Research in Security Prices" at the Graduate School of Business of the University of Chicago. It has taken more than 3Vi years and involved the recording on IBM tape of millions of pieces of information to provide the material for the first publicly released study.
The conclusions of the study as given in a copyright release in 1963 by the University are summed up as follows: "Over the entire thirty-five year period, 1926-60, the rates of return, compounded annually, on all common stocks listed on the New York Stock Exchange were 9.01 per cent for tax-exempt institutions, 8.20 per cent for persons in the $10,000 income class, and 6.84 per cent for persons in the $50,000 income class."
These figures are valuable as indicating broad general expectations concerning common stocks' investment results. On the other hand, they have no practical applications because no investor is possibly going to own all of the 1700 stocks involved nor act in the theoretical way assumed. Nobody knows what the next 35 years hold in store.
Sound logic and reasoning as to the future is certain to pay off much better than any formula plan.