Conservative Investment Principles
A PROFESSIONAL man who had accumulated $100,000 over a period of twenty-five years, through persistent saving and careful investment, suddenly realized that his son and only heir was not only unequipped to earn his own living, but was also quite without experience in investment. It occurred to the parent that the safest thing to do in the circumstances would be to place all of his securities in the hands of a trust company with the understanding that the latter would manage the estate, after his death, and pay to the son the annual income which the trust earned. By this means the son would never come to want.
But this plan had objectionable features. True, the son was weak from inexperience, but why make him weaker? Why not let him learn to assume responsibility in investment under the parent’s tutelage? After all, was not experience a far more valuable heritage than wealth?
The parent decided to put the responsibility of all future investment directly on the son’s shoulders, acting himself as friend, observer, and counselor in time of need. He drew up a list of principles which had served him faithfully as investment guides, and insisted that the son master them.
These principles have been framed by a professional man to fit the peculiar needs of his own class, yet they can be applied to-day with almost equal force to the needs of any other class of conservative investors.
1. No investment is absolutely safe. There is no bond or share of stock in existence which should be ‘locked up and forgotten,’
2. When the price of one of your securities becomes so high or so low that you would not buy it at that price, you should sell it. Hold only when you would be willing to buy at the current price.
3. It is future income that you want. Buy for income primarily, not for appreciation in value.
4. A non-dividend-paying stock must double in value once every twelve years if it is to yield a return of 6 per cent.
5. It accomplishes nothing to sell your securities, because you see a ‘profit’ in them, if you immediately reinvest in other securities which have also risen in price.
6. The buyer of a diversified list of investment stocks is not a speculator. Some stocks are better than some bonds.
7. A business man can afford to hold 60 or 80 per cent of his securities in the form of diversified stocks with an established dividend-paying record.
8. Not more than 25 per cent of the investments of a widow should be in the form of stocks, and then only in a highly diversified list, of investment stocks. The balance should be in the form of seasoned bonds — they require less watching.
9. The great advantage of owning common stocks is that the dividend rate is not fixed by contract. As the company prospers, the shareholder may receive larger dividends. The owner of bonds can receive no more than a fixed interest return. In a period of rising prices, he may find that the purchasing power of his fixed interest income has been materially diminished.
10. The smaller the investor, the greater should be the proportion of bonds in his holdings.
11. When buying stocks, buy only investment stocks — the stocks of companies having a record of stable earnings, stable dividends, and conservative management.
12. Don’t buy the stocks of two or three competing companies in the same industry. Choose the strongest company in the industry and buy its stocks.
13. Diversify holdings of stocks and bonds according to type of business of the issuing company; territorial location of the business; maturity; yield; marketability.
14. Type of business. Public-utility companies, particularly gas companies, electric light companies, and telephone companies, have the greatest stability of earnings. Railroads come next, and industrials last. While some industrial companies have remarkable stability of earnings, as a class they are peculiarly subject to the ups and downs of the business cycle, to new competition, antitrust legislation, tariff changes, and the like. Place your investments in more than one kind of business, and favor the type which has stability of earnings.
15. Territorial location. An investment equity spread over various sections of the country is better than the same equity concentrated locally in one business or property. A railroad bond secured by a lien on the entire main line is better than a branch-line bond. For the same reason a bond or share of stock of a company doing a nation-wide business is normally better than the securities of a small company doing business over a small area.
16. Maturity. Bond maturities should be arranged so that a certain proportion of the bond holdings will mature each year. This makes it possible to obtain average investment results — that is, to have funds to invest when interest rates are high no less than when interest rates are low. One of the best instruments for regulating bond maturities is the real-estate mortgage bond. As a rule, these bonds mature serially, and you can readily select the maturities which your investment list requires.
17. Yield. When buying a stock or bond of very high yield, make an equal investment in a low-yield security. The average man cannot get more than average results. Don’t flatter yourself that you’re above the average.
18. Marketability. One must pay for marketability in a security. Don’t buy more marketability than you need.
19. The small investor can get little benefit from tax exemption on his bonds. It is likely to cost him more than it is worth.
20. Assuming that one has a fund of $5000 to $200,000 for investment, that 60 per cent is to be put into bonds, and 40 per cent into investment stocks, the following schedule is suggested as a good model for securing proper diversification, maximum yield with reasonable safety, and opportunity for growth, although individual requirements or special knowledge might call for a different arrangement: —
Real-estate mortgages 15%
Railroad stocks and bonds 20%
Public-utility stocks and bonds 30%
Industrials, mostly common stocks 20%
Foreign government bonds 10%
Municipals and other tax-exempt bonds 5%
21. ‘Put not your trust in money, but your money in trust.’ Arrange with a reliable trust company to take care of your securities under a Fiscal Agency agreement. The cost of such service is well within the reach of everyone who has $10,000 to invest. The trust company will buy or sell on order, clip coupons, make out incometax returns, watch for ‘called’ bonds, and render any amount of statistical service free of charge. It will seldom be necessary for you to see your securities. Maintain a checking account with the same trust company, and try to keep an average cash balance of at least $.500. It will ensure service in an emergency.
22. You can afford to devote study to your investments. Take an interest in the company whose securities you own. As a shareholder, estimate the probability of the company’s earnings falling off 50 per cent over a twoor three-year period. Could dividends be maintained during such a period? When did the company have its worst year or years, and how did it come through ?
23. As a bondholder, note by how much the earnings available to pay interest exceed the actual interest charges. In practically all cases, earnings before interest should be at least twice the amount paid out in interest. In companies whose earnings are subject to wide fluctuation, earnings before interest should be three or four times interest charges.
24. Decide on the amount you should save every year and stick to it. Save $500 a year for fifteen years, keep principal and interest invested to yield an average return of 5 per cent, and your savings will accumulate to $11,328. Continue the process for ten years more and you’ll have $25,056.
25. Cultivate thrift and conservatism. Teach your wife and other dependents the value of thrift and independence; diversification in investments; dealing only with the most reputable investment houses; following the beaten path.
Was the parent conservative in his estimate of human intelligence — as he must have been in his investments — when he risked $100,000 on the belief that an amateur could learn the value of these suggestions and become a fairly intelligent investor? To-day the parent declares that this particular venture of his, initiated almost ten years ago, turns out to have been the safest and most satisfactory investment he ever made.
GEORGE E. PUTNAM