The Diary of a Prudent Investor. Ii

This department is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give advice as to specific investments.


JIM BLAKE’S 1 first salary increase came a year after lie started work in the store. Three dollars were added to his weekly pay of fifteen dollars. Jim recognized that his needs had n’t changed at all, and he resolved to save the entire increase, which he bombastically thought of in terms of $156 a year.

The next milestone was reached after his savings account showed a balance of $300. Jim regarded this as real capital, and thought that the time had come to begin buying securities on his own. He realized the advantage of placing his first savings in comparatively riskless investments such as government bonds, but they did n’t seem to fill his needs, because he felt that he already had the equivalent of high-grade bonds in his endowment insurance policy, since the company was regularly investing his premiums in high-grade securities and mortgages. At twenty-four, without dependents, he was unattracted by risklessness. He knew what he wanted. He sought beyond all else the promise of growth — the hope of an increment in his slender capital fund. After twenty-five years of accumulation, he might become primarily interested in conserving his capital, but now he was single-mindedly searching for ways and means of emerging from the propertyless class.

Yet Jim knew that hazards accompany the pursuit of profit, and, though he was perfectly willing to assume business risks, he did not wish to handicap himself with extraneous hazards, unrelated to business itself, such as margin speculation or dealing with disreputable vendors. He never forgot the preachment of his economics professor that margin speculation on borrowed capital tends in the long run to force operators to reverse the sound procedure of buying low and selling high. In the nature of things, the margin operator has the most buying power when prices are high and are rising. On the other hand, he tends to become a necessitous seller after security prices have collapsed.

Accordingly, Jim decided that the best system was to buy for cash, through his own bank, leaving to the banker the responsibility of selecting an honest broker to execute orders. In his own way, he considered the $300 which represented the bulk of his free savings just as important as the $300,000 fund of a wealthy man.

Jim’s main criterion, in selecting securities, was the yardstick of promise of appreciation. His point of view was that the older industries, which were admittedly more stable, had approached a saturation point and that their future expansion, if any, would be relatively slow. For example, he didn’t believe that there was any killing to be made in the railroads, or coppers, or the sugar stocks. But he did believe that new opportunities were as inviting as the older industries had been in pioneer days, and remembered the rapidity with which material progress had transformed the country from a wilderness into a civilization of unparalleled high living standards. Accordingly, he began to search for the answer to this pivotal question: What new industries, what new products, are emerging which offer reasonable promise of growing in geometric ratios?

His mind turned to radio, television, talking pictures, aviation, steel alloys, plastics, prefabricated houses, air conditioning, and electrical refrigeration. With hopes running high, Jim placed his funds in six stocks. Realizing that he was playing with dynamite, he sought safeguards through diversification. He apportioned his $300 as follows: —

X-Ray Television Co $30
Uneeda Gold Mines, Inc 70
Universal Steel Alloy Co 80
Vitamold Plastics, Inc. 20
Deep Shaft Oil Corp 40
Golden Wings Aviation Co 60

But for a lucky accident, the whole sum would have been written off as tuition for investment experience. To say that time was unkind to these ‘investments’ would be magnificent understatement. Time ignored them — that is, all except one, the Universal Steel Alloy Co., which finally made good when it was bought out by a large and successful corporation. The other five folded up as soon as they had exhausted the supply of gullible capital. At the end of two years, however, Jim’s $80 purchase of Universal stock had risen to $1.50. Fortunately this enabled him to salvage halt his capital after his first adventure in getting rich quick through the stock-acquisition route.

From this experience Jim developed a healthy skepticism toward untried schemes, recognizing that there is an added value to companies which have demonstrated a capacity for survival in the rough-and-tumble of competition. He now laid greater stress on the actual record of accomplishment, and thus learned to distinguish between competently managed companies which through research were in tempo with progress, on the one hand, and mere promotions which, though purporting to be the last word in novelty, lacked skilled management. ’The initial adverse experience did not turn him from stocks; it merely made him a more discriminating buyer.

He concentrated on well-managed companies in unsaturated industries, with an unusual growth factor. He was indifferent as to whether they paid dividends or not, as long as the companies were growing, doing well in competition, offering reasonable expectation of a hopeful future.

Jim gradually improved the quality of his stock investments, until by the time he was thirty years old his holdings were worth $10,000. By that time, salary increases had gradually brought his stipend up to $4000 a year.

For more than eight years, he and Alice had tacitly assumed that some day they would be married, but until now Jim did not feel ready to present his sweetheart with a bill of particulars. When they finally announced their engagement, Mr. Winthrop, by way of a wedding present, raised Jim’s salary to $5000.

Marriage, as was to be expected, introduced new ingredients into Jim’s recipe for prudent management of his purse strings. The young couple promptly agreed that half their savings should be regarded as a nucleus for buying a home, but it was soon discovered that this nucleus was too meagre for a down payment on the particular house which attracted them. Alice was suddenly inspired with one of those ideas which so often beset young matrons w ith more ambition than experience.

Jim had the right financial objectives, his wife declared, but his methods were too slow. “Why not emulate Cousin Charles, who had scoured Wall Street clean by buying on margin? The repetition of this suggestion finally had the effect of water dripping on stone. Reluctantly, Jim at length yielded to her persuasion, threw his better judgment to the winds, and took a fling at margin speculation. This meant buying about four times as much stock as he could afford.

In this new speculative rôle he made the common mistake of continuing to act as though he were a cash investor buying for the long pull. With $5000 as margin, he opened a brokerage account, and authorized his broker to buy $20,000 worth of stock for his account and risk. The prevailing financial gossip was distinctly optimistic, so that Jim thought the risk involved was more or less academic. By one of the common freaks of fortune, however, an unforeseen factor was suddenly injected into the financial situation

talk of war in Europe. As the rumor approached certainty, stock prices broke wide open. The floor of the New York Stock Exchange became a frenzied scene as bids were temporarily withdrawn for pivotal stocks. Before order was restored, the averages registered a twelve-point drop.

Before Jim realized what had struck him, his broker, who a fortnight before had told him he could n’t go wrong, telephoned for additional margin. Jim decided to stick it out, sending down a check for $3000 in order to restore his account to a comfortable position. But the market continued to toboggan. The broker clamored for still more margin — and within twelve hours. Jim then concluded it the better part of wisdom to sell half the stocks in his account, and thus reduce his indebtedness to the broker.

Then came the calm after the storm. The market lay dormant — and interest charges on the borrowed funds began to accumulate against Jim.

Then the market took another drastic turn for the worse, and, thoroughly alarmed, Jim decided to sell half of his remaining holdings. Soon thereafter, the reaction was arrested. Prices began to rise on a refreshing breath of optimism, growing out of war orders, and enjoyed a prolonged uptrend.

But as a result of the successive shakeouts Jim found himself with only $5000 worth of stocks in his account — one fourth of his original commitment — or about as much as he would have taken on if he had bought for cash. In the meantime, he had created substantial commissions and interest charges for the broker and had sold at the wrong time when prices were low. The lesson had cost him $3000 in losses, and he was that much further from buying the home of his dreams than he had been six months earlier.

But Jim charged up the adventure in trading to experience, and reverted uncompromisingly to his earlier and safer investing technique. He was convinced more than ever of the unwisdom of putting himself out on a limb through going into debt to buy securities.

  1. This is the second of four installments presenting the life story of an investor as he moves around the circle from youth to old age. — EDITOR