The Current Investment Problem
ON a certain day approximately forty-seven years ago, a fine carriage drawn by two handsome horses, a coachman and a footman on the box, was brought to a stop at the door of a certain banking house in lower New York. A lady and a gentleman stepped out and went into the bank. They had come merely to see about the reinvestment of their capital, which consisted wholly of U. S. Government 5’s and 6’s issued during the Civil War, bought at that time or shortly thereafter, probably paid for, in part at least, with depreciated greenbacks, and now maturing. They would simply relend their money to the Government. They were due uptown again in an hour and a quarter.
But the U. S. Government of 1881 was not the U. S. Government of 1861. Conditions had changed. A rental of 3 per cent, or at most 3½ per cent for a short period, was all the 1881 Government would pay for money — paper money the equivalent of gold, and no discount allowed. So the banker informed his clients. They were dumbfounded.
For years they had been relying on a safe investment which had never yet failed to pay them 6 per cent. Their principal was still intact. Why, all of a sudden, should its ability to produce income be cut in half? Their standard of living required a 6 per cent income. What were they to do?
When a desired income can with reasonable safety be secured only from 100 per cent more capital than has been capable of producing it in the past, the investor has only three courses to follow : accept less income, be content with a reduced margin of safety, or put up the requisite additional capital. Our 1881 investors immediately disposed of their carriage, horses, footman. and other servants, and adopted a scale of living in keeping with a greatly reduced income.
The lesson of 1881 should be instructive in 1928. Within the last few years millions of long-term, high-coupon bonds have been called. Preferred stocks in many cases have been redeemed or replaced by obligations bearing lower rates. Common stocks have so risen in price that the‘averages’ have touched new highs frequently of late. Yields are low. The Government borrows for short, terms at 3¼ per cent.
Conditions since 1921 have greatly changed, as they had from 1861 to 1881. To-day’s investor is likewise confronted with the alternatives of adopting one of the three courses mentioned above, or of doing a much better job of investing than he ever has done before.
The first of these alternatives is a budgeting, rather than an investing, problem. To regard principal as principal, and income as income, may be a convenient procedure and sanctioned by law. But certainly it is not always a safe procedure for the investor who is spending all his income. Investing is a business. The business which pays out all its earnings in dividends, without any provision for building up a surplus to tide over inevitable lean periods, is a poorly managed business. To avoid the results of such poor management, the investor will see that his ‘business’ by some method or other builds up a comfortable surplus. A wonderful opportunity for building such a surplus has been presented over the last few years. If perchance the investor has not taken advantage of this opportunity, he had better adopt a budgeting plan immediately in addition to improving his investment practice. This may save serious trouble later on.
A word of caution regarding safety is necessary.
When Baldwin apples grade A sell for $5.00 a box, one can be fairly sure that $4.00 will not buy a box of grade A Baldwins. When grade A bonds sell on a 5 per cent basis, one can be fairly sure that bonds yielding 6 per cent are not grade A. Serious danger lies in the current temptation to barter safely for high yield. Remembering the yields of yesteryear, many are searching the byways and hedges for some attractive issue which others, the hope is, may have overlooked. Diligent arguments are adduced to justify departures from sound principle. But without expert advice the investor had better not own the poorer risks. Certainly there are attractive grade B bonds and stocks. Certainly some investors may safely and profitably own them. But the danger lies in owning them without a full appreciation of the risks involved, and without the knowledge or the power to minimize those risks.
With regard to an improvement in investing tactics, two suggestions are offered.
First, let the investor base his judgment on pertinent facts which exist to-day. Let him regard change, not permanence, as the normal condition. Sound securities to-day are just as plentiful as they were a few years ago — more so. It is no more difficult to compare the merits of different securities to-day than a year ago to-day. The difficulty is inherent in the investor’s unreadiness to recognize, appraise, and act upon changed conditions. He is still basing his judgment on prices that no longer exist, and price by itself is not a pertinent factor. An $8.00 stock selling at 200, other conditions being equal, is the exact equivalent of a $4.00 stock selling at 100. To-day’s average market prices have recently touched their high for all time, but so have dividends and earnings. Yields, however, have not yet reached their lows for all time, nor for the present century. We are simply in an era of high prices, which of itself means nothing. It is yield, the relationship between price and return, which is significant.
The second suggested improvement in tactics is that the investor prepare and follow a definite forward-looking plan. If the companies listed on the New York Stock Exchange were managed with the same looseness as the ordinary invested fund is, not one of them would be a sound investment risk. Money rates very likely will recede further. They may, however, rise during the next, few years. Sound securities will yield less, or more. To offset receding rates, the investor should have an interest in that type of security which pays an extra dollar now and then. To offset the casualties that may occur when rates are advancing, he should own sound fixed-income-bearing securities. He should not follow the usual method of hand-to-mouth buying, with a fine disregard for the type of investment which suits his particular needs under current conditions. It is more important than ever that he adhere to a sound programme.
As this is written, business is steady. Certain Federal Reserve banks have recently raised their rediscount rates, thus discouraging expansion of credit. Large amounts of gold are being sent abroad. In face of a declining gold supply, the Federal Reserve banks are still selling government securities. Regardless of the temporary effect of these factors in raising money rates, or at least holding them steady, the longterm trend may still be downward. A lull in the trend, resulting from these factors, should give the investor a comfortable opportunity to design and adopt a sound investment policy. Otherwise a revision of his budget may be enforced.