-: Welcome once again as MIT Professor Paul Samuelson,
discusses the current economic scene.
-: This series is produced by Instructional Dynamics, Inc.
This program was recorded March 14th.
-: I'd like today, to shift the discussion
from what's happening to the general business situation.
I also don't want to discuss the energy crisis.
That's been discussed a great deal.
But instead, I'd like to be responsive
to an awful lot of questions that have been coming to me,
some of them from subscribers to this service,
many from readers of my Newsweek column,
but even more, because I'm an economist.
I've been approached by various groups of investors
who for the first time in a long time,
seem to be desperate for general advice.
There's a kind of a loss of nerve that has taken place
in the investment community.
So, I'd like to talk about some problems
of personal finance.
How should a person, let's say a physician
whose making a good income, but whose getting older,
and is going sometime to face a period of retirement,
how should he manage his private investments?
How should the person of more modest means than a physician,
let's say somebody who works for a corporation
and has some kind of a pension plan down at the office,
how should he handle his common stocks?
Should he be buying bonds?
Should he be putting his money in the savings account?
This is a universal problem.
You're a very unlucky person if you don't,
in some degree, face up to this problem.
Now, even if you're unlucky, there is a similar need
for prudent personal finance advice.
As for example, whether you should buy on time,
if you have any choice at all?
Or whether if you buy on time,
through a, borrowing from a personal finance company
rather than through a bank and so forth?
Well now, these questions are obviously very broad.
I want to make a disclaimer at the very beginning.
If you are of any sophistication, you will not expect me,
as a professor of economics,
to know the answers to those questions
with any kind of finality.
And, you'll also know that even the opinions which I have,
I will be very guarded about in the way I give them out,
because there is nothing more dangerous
that any person can do than to give indiscriminate advice.
Really to advise properly a person,
you must first know a great deal more than I know,
or than I dare to say,
the typical professor of economics knows.
But in addition to that, you must know a great deal
about the person who has come to you for advice.
You have to be, so to speak, his spiritual advisor.
You have to know what his attitude towards risk is,
not just as he states it to you,
but how he will in fact, behave through time,
whether he's a crybaby about investments that go sour
or don't do as well as his most optimistic dreams.
It isn't even enough to know him in a way that perhaps
only a psychoanalyst can know him.
You must know his wife,
because the biological team of husband and wife
is an entirely different investment animal
than the husband himself.
I've said more than once, and once wrote this in print,
that the best investors in my experience,
are bachelors with hearing aides.
Now that sounds like a flipping joke,
and of course it is a joke,
but there is a deeper significance to it.
First, the bachelor is responsible only to himself.
And therefore, he does not have to do
what anybody else almost has to do.
Any trustees certainly has to do it.
Any spouse, I think, ought to be doing it.
Namely, think about how he will be judged by other people.
Whether there will be recrimination
if he puts his money into that great gold mine
in the sky or on Earth, and it turns out
not to be where it was thought to be.
Most investment decisions, I think, are made by people
who are not making them just for themselves.
The other reason why the bachelor of the hearing aide
is the good investor, that's an attempt by me
to explain, indicate,
that you got to do an awful lot of work
to be a good investor.
You have to sit there in the silence of the reading room
of the New York Public Library
or your local university library,
and you have to be prepared to dig into Moody's.
In the long run, there is very little luck
in the pursuit of security analysis,
and there are a thousand ways of losing your money.
And I'm sorry to say, there are a thousand ways
of losing a little bit more than the average amount
that has to be lost.
And it's only people with lots of time
and with an interest in the matter
who can be expected to do that kind of digging.
Even being interested can be as dangerous and as bad
as not being interested, because suppose you are
a person with gambling instincts,
then I think you can do a great deal of harm to yourself
by indulging those gambling instincts
in the handling of your own private investments.
I always advise somebody with gambling blood,
to go to the horse races or the dog races
where the odds are very much stacked against him,
but to discharge that impulse in the rather limited way
of say losing no more than $300
on a visit to Las Vegas on a weekend.
You're gonna lose that money with a very great probability,
but it's much better to lose with certainty $300
than to be fooling around,
buying soy beans or selling soy beans short
on the basis of your family's eating money
or it's ultimate security, retirement money.
And, it does make a big difference.
I once quoted a thing attributed
to one of the Warburg institutions.
Probably most of these stories are apocryphal.
They're always being attributed
to the Rothschilds or to J. P. Morgan.
But somebody asked the Warburgs
how come they had such good batting average as investors,
and one of the partners said thoughtfully,
"Do you suppose that it's because we take money seriously."
Well, if you see a typical, I even dare to say,
a professor investing his money
or a typical professional person,
you wonder whether he really does take money seriously,
because he hears down at the tennis club
that somebody has a marvelous way
of administering medicine under the skin,
and he can get in on the ground floor.
It may have a 1000 to 1 price earnings ratio
or preferably, it has an infinite price to earnings ratio.
I'm told one of the biggest mistakes for a growth company
is to get positive profits
because then people will try to decide
whether the price earnings multiple is excessive,
whereas, if you have no profits, the sky is the limit.
It's only your future that counts.
Well, that's a very long preamble.
Let's now get down to some details.
First, I think it's very clear
that it depends upon your age,
your income class, your wealth,
what the nature of good advice to you would have to be.
And, I'm thinking of somebody whose affluent enough
to be listening to a service like this,
who has some real investment problems,
let's say, who has a net worth of $30,000
or $50,000 or $100,000 or $1,000,000.
Or alternatively,
and this is quite a different consideration,
somebody who is investing money for a portfolio
of 10 million dollars or 100 million dollars
or a billion dollars.
They're probably aren't too many people
who have a billion dollar pool of assets to watch.
I don't think my advice is necessarily going to be bad
to somebody who has 25 billion dollars of assets.
I think there's only one group in the world
who have 25 billion dollars under their control.
It's of course, would be know to anybody of experience,
a particular trust department
of one of the large New York banks.
Then there are still others that have 15 billion.
And if you're running
a very large constellation of mutual funds
or investment management counseling organization,
you will without difficulty, quite possibly,
be in the billion dollars of asset range.
I don't think that the advice that has to be given to you
provided that you have more than
let's say 10 million dollars
is very sensitive to the size.
I know that there is an illusion
that a large pools of money are handicapped
in comparison with small pools of money.
But if you think through the actual mechanics of investment,
and if you appraise properly performance
than you'll find that most of that is an illusion.
Well, let me talk about people with $50,000 or $100,000,
because God must have loved them more.
He made a heck of lot more of them
than of people with 100 million dollars.
I'm quoting Abraham Lincoln.
The first question to ask is
how do you preserve the capital you have?
How do you preserve it in real terms?
What counts to you?
Which is it's purchasing power in whatever use
you're likely to wish to make of it in the future.
And, I don't think the problem of
how to preserve your capital is different in kind
from how do you enhance the amount of your capital?
What you're trying to do is preserve it
in an algebraic sense, and of course,
if you could, with less risk actually increase it.
Then any investment strategy which enabled you
to increase it, would be the optimal one.
I'm already casting some doubt on the distinction
between a speculator and an investor.
There are rash investors and there are rash speculators.
But everybody has the same problem I think which is
other things being equal, avoid ending up with less.
And other things being equal, try to,
with great probability, end up with more.
Now, if I had been talking to you 20 years ago,
and somebody had asked me the following question,
what is the role of common stocks, of equities
in such a portfolio,
this on the assumption that you don't have to stay liquid
for any purpose so that within 24 hours
you have to be able to tap the money,
I would probably have given the following answer.
If you must go away on a trip around the world,
it's going to take you five years say,
and you must leave in an envelope for your trustee
the instructions on the percentage
that he should hold in common stocks
as against the percentage
that he should hold in other instruments, treasury bills,
long term government bonds, bank accounts, what have you,
then probably the best single number
that you can give is a high fractional number
moving up to and even including 100%.
In other words, I read with approval 20 years ago
an article in Barron's which said that
the Alumni Foundation Fund of The University of Wisconsin
which came into existence sometime in the late 20's,
because certain inventions were made
by professors at the university there,
usually in the agricultural division,
and the royalties came in on those.
I'm thinking of vitamin D and irradiation,
and I think certain Babcock tests for cream separation, etc.
That fund was 100% in equities from it's beginning,
and it went through, if I recall correctly,
the great stock market crash of 1929.
100% invested in equities.
It came back from the great valley of 1932.
It went up and down the rollercoaster of 1937-38.
And in the war years,
when 35% of value of stocks went down,
it, no doubt, went down.
And yet over it's lifetime, it had an extremely good return.
And similarly, again we're talking about 20 years ago,
if you'd looked at a whole bunch of colleges,
you'd have found that the colleges which did best
were colleges like Wesleyan.
Now, Wesleyan no doubt had a good treasurer,
no doubt had some very loyal alumni
with some very good ideas,
but the major reason why it was doing better
for quite a number of years,
was that instead of being right there with the mob,
with 50% in equities, which was perhaps
a typical college figure 20 years ago,
they were 80% in equities.
Indeed, if you follow the logic of this
that 100% is better than 80%, and 80% is better than 50%,
because stocks are a great buy,
then the fellow who actually went out and borrowed money
and leveraged through a margin account or otherwise,
who had 130% in equities, he was the smartest fellow of all
in terms of presumed average return or mean return.
But of course, he'd be an unusual man, a person,
if he slept as well at night when he had borrowed money,
because when you go into stocks with your own money,
you do have limited liability.
And the stock can become worthless, in which case,
you tear up the certificate and walk away from it.
But if you actually are selling short,
or as in this case, you are borrowing money
and buying the stocks on the borrowed money,
then you can find that as the stocks fall
to even less than 100% loss on your equities,
you are absolutely wiped out and
there's no way of giving a stop loss order
that will make perfectly sure that you won't in fact,
end up with negative net worth, owing.
And so, you're in the position of social disapprobrium.
You are in bankruptcy or otherwise.
Well now, why was it that 20 year ago,
one might have given this kind of advice
and have a recent story to support it
when that is certainly not the case now?
The very fact that men of means are reduced
to coming to professors of economics
for general counsel and advice
shows that there is a failure of nerve,
and nobody would believe you
if you said the wisest thing today
is to have 100% of your money in equities.
I think the reason for that was
that people 20 odd years ago,
maybe I should make this all 25 years ago,
generally who had lots of money were old enough
to remember The Great Depression and
the great stock market crash of 1929.
The result is that they never really trusted common stocks
even when you could buy common stocks
at four to 1 price earnings multiples
when they were yielding 9% at the same time
the gilt-edged bonds were, in those days,
yielding 2 1/2%, 3 1/2%, and mortgages were only at 4%.
The result was that World War II,
and what it had irreversibly done to the price level
was not really recognized and built into the marketplace.
Now, if what I'm saying now is inconsistent
with the random dart hypothesis of the stock market,
then I must confess that I'm not a believer
in the Random Dart Theory,
because I do believe that there are times
when the general level of stocks
are high and unfavorable and other times
when relatively speaking, they are low and favorable.
I'm not trying to say that it's easy to discern those times,
and it certainly is hard to prove
that you're right if you do have such an opinion.
And certainly, the methods of proof cannot be those
of geometrical and logical demonstration
beyond a shadow of doubt.
And they can't even be of the empirical type
which the physicists can enjoy.
That he can say that nobody's going to see the speed
of light in a vacuum exceed that of a certain constant
or nobody's going to be able empirically
to build a perpetual motion machine
of either the first kind or the second kind.
Well no proofs like that are possible.
But in any case, what happened was
that just as we were in that period of 20,
of 25 years ago when stocks were great buy,
the message slowly began to spread,
and I would almost name 1953 as the time
when it began gradually to be realized
that stocks were a good buy.
And I traced the great decade increase
in the price earnings multiple of the whole array of stocks
to that subsequent time period.
All this has been documented in some detail
by the famous Merrill Foundation Study
done at the University of Chicago
by Professors Lorie and Professors Fisher
and a number of other competent analysts.
I may say ironically, and I say this
in no sense of criticism whatsoever,
that Merrill Study has probably lost a lot money
for a lot of people, or at least,
it has given rise to lots of dreams of avarice,
of how well people were going to do,
only to find that their actual experience
subjected them to a lot of regret,
because let me quote what he Merrill Study showed.
It showed that if you started at 1925,
and you just sort of bought everything on the board,
just throw a dart, or more specifically,
put a dollar in everything listed on the financial page,
and do this everyday.
Sell out each night and go in, in the daytime.
I exaggerate just a little on how often
you'd have to turn over your portfolio.
Then you would do extremely well.
And, this includes the period of the crash
and The Great Depression.
Of course, if you started out in 1929
and then reckoned where you are in 1932,
you have a miserable performance.
But if you started in 25 and did it all the time,
then the average up to 1960, 1965,
your average rate of return would have been extremely high.
I don't remember all exact categories,
but let's say something like 9% per annum.
When we reckon these rates of return,
of course, we're reckoning them
in terms of dividends plus capital gains.
Whether you take those capital gains or not,
that's the only way to properly make commensurable
two different kinds of investments.
Well more than that,
the best part of this return we're talking about,
came in that fabulous period of the 1950's
when people were just gradually beginning to become aware
that higher price earnings multiples seemed
to be indicated for stocks.
And the people who became aware of that early,
of course, bought at low price earnings multiples
and were in a position to sell out as they so chose
at high price earnings multiples.
Well, a secret cannot be kept indefinitely.
And just as the mob went too far in my opinion,
in say in the 1953 period in discounting stocks,
the mob finally caught up.
And by the 1960's, let's say the middle of the 1960's,
people had begun to read the Merrill Foundation Studies.
By the way, these Merrill Foundation Studies
are completely nonprofit.
They're not for the purpose of making customers
for Merrill Lynch or for any other brokerage organization.
They were a truly tax exempt gift with no strings attached.
And there's never been the slightest shadow of suspicion
that the computer studies made
were anything but completely objective.
When you finally begin to get the belief
that you could coin things, easy money,
by good stock market selection,
and a lot of people of course,
thought they could do better than the random dart,
and you had the performance cult developing
and the so called gunslingers.
Now the young people really in the saddle, and they thought
that they could spot Kentucky Fried Chicken early
or Ling early, or other growth situation
when they still had low price earnings multiples,
and that they would be able to sellout
at high price earnings multiples, and
that they would be able to recognize
early rapid growth, earlier than other people.
It became so widespread that every pension fund
began to increase the percentage it had in equities.
And the typical pension fund,
and I'm sorry to say this still tends to be the case,
kids itself that there's 9% let's say to be made
in the standard way, by a stock market pension fund
or even by a balanced pension fund
and with a little extra cleverness
for which they're prepared to pay,
and you could really afford to pay, they'll make 11%.
And therefore, it won't cost the company so much.
Well, the truth of the matter is,
and this is the first thing that one should realize,
when one studies the batting averages
of all the groups in the market,
when one studies all of the methods proposed for investing,
one realizes that there are almost no people,
and I don't care whether you're in the biggest banks
or whether you're in the most successful mutual funds
of the last half decade, there's almost no group
which systematically can beat the comprehensive averages.
In other words, if you were to simply buy all the shares
that are outstanding in the New York Stock Exchange,
the American Stock Exchange,
and let's say the over-the-counter market
where at least the stocks are of a certain size,
you would find that such a portfolio
would do as well or I dare to say, better than 99 out of 100
of the best money management groups in this country.
Moreover, you wouldn't use a crude comparison
of where you started in say 1960,
and where you ended in 1965, or where you started in 65
and where you ended in March 1974.
A clever person, an informed person,
would correct for risk.
And if the market's going up
and a person is very risk-taking, then obviously,
by borrowing or by buying volatile and risky stocks,
he can get a better arithmetic mean of return,
but at the expense of a greater standard deviation
of dispersion and of risk.
And there are lots of methods
which have been pioneered in the finance departments
of business schools of this country
that correct for the differential amount of risk.
So, I think the first lesson,
and in a half an hour one can't really do better
than to go into the first lesson,
is a lesson in humility.
We don't know what the proper fraction
of a prudent portfolio ought to be in equities,
but playing safe, it will be some fractional number.
Some fractional number in equities
and some fractional number in fixed principle assets.
We have no reason to believe that by cleverness
or by spending money on security analysis,
we will be able to do better
than the comprehensive averages.
This means, my time is now running out,
that we're long in need of a reform
in which the ordinary citizen of small means
or of large means is able to buy a prorated share
of all there is outstanding to buy.
Let's say a no-load mutual fund, a no management fee
or low management fee mutual fund,
a low commission mutual fund which simply invests
in the Standard and Poor 500 Index.
Now, I mention that because it's a pretty good approximation
to all there is to hold.
But of course if we really had this,
then it could invest in all there is to hold
and go beyond The Standard and Poor 500.
Moreover, this is something which is available
to a person with 20 billion dollars.
Now why is that?
Well suppose that you have your
20 billion dollars in IBM and Xerox and Avon and Polaroid
and the so called one-tiered stocks,
and you should, God forbid, change you mind
and decide the prospects weren't so good for one of those.
Obviously, you cannot sellout without depressing the price.
Whereas, if you own a little bit
of everything there is to own, even with 20 billion dollars,
you will be in a very liquid position.
I want to bring this discussion to a close.
Obviously, the problem is not for people
who have 20 billion dollars,
but I think there is a clear moral.
That fraction of your wealth
which ought prudently to be in equities,
ought to be in a diversified list of equities,
acquired by you with low-load or zero-load,
and so widely diversified
that no expensive management fee is payable.
A good test of performance
would be a very low turnover ratio,
because all the money that's paid out to brokers
according to the facts of experience,
if you believe in the safety in the total market,
is a dead weight loss.
Moreover, it's a dead weight loss where it hurts the most.
Namely, it comes out the capital gains part
of the portfolio, the likely tax part of the portfolio.
Well, I think there's a very important lesson
to be learned there.
I want to go on to say that I've given this sort of advice
for handsome fees to some very important investors.
But I always tell them this is advice you will not take,
and I've very rarely been proved wrong.
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