Tape 149 - How to invest lesson #1: stocks versus non-stocks; diversified piece of whole market
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- | Welcome once again as MIT Professor Paul Samuelson, | 0:02 |
discusses the current economic scene. | 0:05 | |
- | This series is produced by Instructional Dynamics, Inc. | 0:07 |
This program was recorded March 14th. | 0:11 | |
- | I'd like today, to shift the discussion | 0:16 |
from what's happening to the general business situation. | 0:20 | |
I also don't want to discuss the energy crisis. | 0:23 | |
That's been discussed a great deal. | 0:27 | |
But instead, I'd like to be responsive | 0:30 | |
to an awful lot of questions that have been coming to me, | 0:32 | |
some of them from subscribers to this service, | 0:37 | |
many from readers of my Newsweek column, | 0:39 | |
but even more, because I'm an economist. | 0:43 | |
I've been approached by various groups of investors | 0:47 | |
who for the first time in a long time, | 0:55 | |
seem to be desperate for general advice. | 0:59 | |
There's a kind of a loss of nerve that has taken place | 1:03 | |
in the investment community. | 1:07 | |
So, I'd like to talk about some problems | 1:10 | |
of personal finance. | 1:14 | |
How should a person, let's say a physician | 1:17 | |
whose making a good income, but whose getting older, | 1:22 | |
and is going sometime to face a period of retirement, | 1:28 | |
how should he manage his private investments? | 1:33 | |
How should the person of more modest means than a physician, | 1:38 | |
let's say somebody who works for a corporation | 1:47 | |
and has some kind of a pension plan down at the office, | 1:51 | |
how should he handle his common stocks? | 1:54 | |
Should he be buying bonds? | 1:58 | |
Should he be putting his money in the savings account? | 2:00 | |
This is a universal problem. | 2:04 | |
You're a very unlucky person if you don't, | 2:07 | |
in some degree, face up to this problem. | 2:12 | |
Now, even if you're unlucky, there is a similar need | 2:15 | |
for prudent personal finance advice. | 2:19 | |
As for example, whether you should buy on time, | 2:24 | |
if you have any choice at all? | 2:26 | |
Or whether if you buy on time, | 2:28 | |
through a, borrowing from a personal finance company | 2:31 | |
rather than through a bank and so forth? | 2:36 | |
Well now, these questions are obviously very broad. | 2:40 | |
I want to make a disclaimer at the very beginning. | 2:45 | |
If you are of any sophistication, you will not expect me, | 2:48 | |
as a professor of economics, | 2:52 | |
to know the answers to those questions | 2:54 | |
with any kind of finality. | 2:58 | |
And, you'll also know that even the opinions which I have, | 3:00 | |
I will be very guarded about in the way I give them out, | 3:05 | |
because there is nothing more dangerous | 3:11 | |
that any person can do than to give indiscriminate advice. | 3:14 | |
Really to advise properly a person, | 3:23 | |
you must first know a great deal more than I know, | 3:27 | |
or than I dare to say, | 3:31 | |
the typical professor of economics knows. | 3:33 | |
But in addition to that, you must know a great deal | 3:37 | |
about the person who has come to you for advice. | 3:41 | |
You have to be, so to speak, his spiritual advisor. | 3:44 | |
You have to know what his attitude towards risk is, | 3:47 | |
not just as he states it to you, | 3:50 | |
but how he will in fact, behave through time, | 3:52 | |
whether he's a crybaby about investments that go sour | 3:56 | |
or don't do as well as his most optimistic dreams. | 4:00 | |
It isn't even enough to know him in a way that perhaps | 4:05 | |
only a psychoanalyst can know him. | 4:09 | |
You must know his wife, | 4:11 | |
because the biological team of husband and wife | 4:14 | |
is an entirely different investment animal | 4:18 | |
than the husband himself. | 4:21 | |
I've said more than once, and once wrote this in print, | 4:26 | |
that the best investors in my experience, | 4:30 | |
are bachelors with hearing aides. | 4:33 | |
Now that sounds like a flipping joke, | 4:36 | |
and of course it is a joke, | 4:41 | |
but there is a deeper significance to it. | 4:43 | |
First, the bachelor is responsible only to himself. | 4:45 | |
And therefore, he does not have to do | 4:50 | |
what anybody else almost has to do. | 4:54 | |
Any trustees certainly has to do it. | 4:56 | |
Any spouse, I think, ought to be doing it. | 4:58 | |
Namely, think about how he will be judged by other people. | 5:03 | |
Whether there will be recrimination | 5:08 | |
if he puts his money into that great gold mine | 5:10 | |
in the sky or on Earth, and it turns out | 5:14 | |
not to be where it was thought to be. | 5:17 | |
Most investment decisions, I think, are made by people | 5:23 | |
who are not making them just for themselves. | 5:28 | |
The other reason why the bachelor of the hearing aide | 5:31 | |
is the good investor, that's an attempt by me | 5:34 | |
to explain, indicate, | 5:39 | |
that you got to do an awful lot of work | 5:42 | |
to be a good investor. | 5:44 | |
You have to sit there in the silence of the reading room | 5:46 | |
of the New York Public Library | 5:51 | |
or your local university library, | 5:52 | |
and you have to be prepared to dig into Moody's. | 5:56 | |
In the long run, there is very little luck | 6:01 | |
in the pursuit of security analysis, | 6:05 | |
and there are a thousand ways of losing your money. | 6:10 | |
And I'm sorry to say, there are a thousand ways | 6:16 | |
of losing a little bit more than the average amount | 6:19 | |
that has to be lost. | 6:23 | |
And it's only people with lots of time | 6:25 | |
and with an interest in the matter | 6:29 | |
who can be expected to do that kind of digging. | 6:32 | |
Even being interested can be as dangerous and as bad | 6:37 | |
as not being interested, because suppose you are | 6:42 | |
a person with gambling instincts, | 6:46 | |
then I think you can do a great deal of harm to yourself | 6:49 | |
by indulging those gambling instincts | 6:52 | |
in the handling of your own private investments. | 6:54 | |
I always advise somebody with gambling blood, | 6:58 | |
to go to the horse races or the dog races | 7:00 | |
where the odds are very much stacked against him, | 7:03 | |
but to discharge that impulse in the rather limited way | 7:05 | |
of say losing no more than $300 | 7:11 | |
on a visit to Las Vegas on a weekend. | 7:15 | |
You're gonna lose that money with a very great probability, | 7:18 | |
but it's much better to lose with certainty $300 | 7:22 | |
than to be fooling around, | 7:28 | |
buying soy beans or selling soy beans short | 7:30 | |
on the basis of your family's eating money | 7:33 | |
or it's ultimate security, retirement money. | 7:37 | |
And, it does make a big difference. | 7:42 | |
I once quoted a thing attributed | 7:47 | |
to one of the Warburg institutions. | 7:49 | |
Probably most of these stories are apocryphal. | 7:53 | |
They're always being attributed | 7:55 | |
to the Rothschilds or to J. P. Morgan. | 7:56 | |
But somebody asked the Warburgs | 8:00 | |
how come they had such good batting average as investors, | 8:03 | |
and one of the partners said thoughtfully, | 8:09 | |
"Do you suppose that it's because we take money seriously." | 8:12 | |
Well, if you see a typical, I even dare to say, | 8:15 | |
a professor investing his money | 8:19 | |
or a typical professional person, | 8:23 | |
you wonder whether he really does take money seriously, | 8:26 | |
because he hears down at the tennis club | 8:29 | |
that somebody has a marvelous way | 8:32 | |
of administering medicine under the skin, | 8:35 | |
and he can get in on the ground floor. | 8:38 | |
It may have a 1000 to 1 price earnings ratio | 8:42 | |
or preferably, it has an infinite price to earnings ratio. | 8:45 | |
I'm told one of the biggest mistakes for a growth company | 8:51 | |
is to get positive profits | 8:53 | |
because then people will try to decide | 8:55 | |
whether the price earnings multiple is excessive, | 8:57 | |
whereas, if you have no profits, the sky is the limit. | 9:00 | |
It's only your future that counts. | 9:03 | |
Well, that's a very long preamble. | 9:07 | |
Let's now get down to some details. | 9:12 | |
First, I think it's very clear | 9:17 | |
that it depends upon your age, | 9:19 | |
your income class, your wealth, | 9:24 | |
what the nature of good advice to you would have to be. | 9:27 | |
And, I'm thinking of somebody whose affluent enough | 9:31 | |
to be listening to a service like this, | 9:36 | |
who has some real investment problems, | 9:39 | |
let's say, who has a net worth of $30,000 | 9:43 | |
or $50,000 or $100,000 or $1,000,000. | 9:47 | |
Or alternatively, | 9:52 | |
and this is quite a different consideration, | 9:54 | |
somebody who is investing money for a portfolio | 9:56 | |
of 10 million dollars or 100 million dollars | 10:03 | |
or a billion dollars. | 10:11 | |
They're probably aren't too many people | 10:12 | |
who have a billion dollar pool of assets to watch. | 10:14 | |
I don't think my advice is necessarily going to be bad | 10:22 | |
to somebody who has 25 billion dollars of assets. | 10:26 | |
I think there's only one group in the world | 10:30 | |
who have 25 billion dollars under their control. | 10:33 | |
It's of course, would be know to anybody of experience, | 10:37 | |
a particular trust department | 10:41 | |
of one of the large New York banks. | 10:43 | |
Then there are still others that have 15 billion. | 10:46 | |
And if you're running | 10:50 | |
a very large constellation of mutual funds | 10:51 | |
or investment management counseling organization, | 10:54 | |
you will without difficulty, quite possibly, | 10:59 | |
be in the billion dollars of asset range. | 11:04 | |
I don't think that the advice that has to be given to you | 11:09 | |
provided that you have more than | 11:14 | |
let's say 10 million dollars | 11:19 | |
is very sensitive to the size. | 11:20 | |
I know that there is an illusion | 11:23 | |
that a large pools of money are handicapped | 11:25 | |
in comparison with small pools of money. | 11:31 | |
But if you think through the actual mechanics of investment, | 11:34 | |
and if you appraise properly performance | 11:38 | |
than you'll find that most of that is an illusion. | 11:42 | |
Well, let me talk about people with $50,000 or $100,000, | 11:46 | |
because God must have loved them more. | 11:51 | |
He made a heck of lot more of them | 11:53 | |
than of people with 100 million dollars. | 11:56 | |
I'm quoting Abraham Lincoln. | 12:02 | |
The first question to ask is | 12:05 | |
how do you preserve the capital you have? | 12:10 | |
How do you preserve it in real terms? | 12:14 | |
What counts to you? | 12:18 | |
Which is it's purchasing power in whatever use | 12:19 | |
you're likely to wish to make of it in the future. | 12:22 | |
And, I don't think the problem of | 12:27 | |
how to preserve your capital is different in kind | 12:28 | |
from how do you enhance the amount of your capital? | 12:35 | |
What you're trying to do is preserve it | 12:41 | |
in an algebraic sense, and of course, | 12:44 | |
if you could, with less risk actually increase it. | 12:46 | |
Then any investment strategy which enabled you | 12:53 | |
to increase it, would be the optimal one. | 12:55 | |
I'm already casting some doubt on the distinction | 12:59 | |
between a speculator and an investor. | 13:02 | |
There are rash investors and there are rash speculators. | 13:05 | |
But everybody has the same problem I think which is | 13:09 | |
other things being equal, avoid ending up with less. | 13:13 | |
And other things being equal, try to, | 13:18 | |
with great probability, end up with more. | 13:21 | |
Now, if I had been talking to you 20 years ago, | 13:25 | |
and somebody had asked me the following question, | 13:31 | |
what is the role of common stocks, of equities | 13:33 | |
in such a portfolio, | 13:36 | |
this on the assumption that you don't have to stay liquid | 13:38 | |
for any purpose so that within 24 hours | 13:42 | |
you have to be able to tap the money, | 13:45 | |
I would probably have given the following answer. | 13:48 | |
If you must go away on a trip around the world, | 13:54 | |
it's going to take you five years say, | 13:58 | |
and you must leave in an envelope for your trustee | 14:01 | |
the instructions on the percentage | 14:05 | |
that he should hold in common stocks | 14:09 | |
as against the percentage | 14:12 | |
that he should hold in other instruments, treasury bills, | 14:13 | |
long term government bonds, bank accounts, what have you, | 14:19 | |
then probably the best single number | 14:23 | |
that you can give is a high fractional number | 14:26 | |
moving up to and even including 100%. | 14:34 | |
In other words, I read with approval 20 years ago | 14:38 | |
an article in Barron's which said that | 14:46 | |
the Alumni Foundation Fund of The University of Wisconsin | 14:48 | |
which came into existence sometime in the late 20's, | 14:54 | |
because certain inventions were made | 14:58 | |
by professors at the university there, | 15:00 | |
usually in the agricultural division, | 15:03 | |
and the royalties came in on those. | 15:06 | |
I'm thinking of vitamin D and irradiation, | 15:08 | |
and I think certain Babcock tests for cream separation, etc. | 15:10 | |
That fund was 100% in equities from it's beginning, | 15:17 | |
and it went through, if I recall correctly, | 15:21 | |
the great stock market crash of 1929. | 15:24 | |
100% invested in equities. | 15:27 | |
It came back from the great valley of 1932. | 15:30 | |
It went up and down the rollercoaster of 1937-38. | 15:35 | |
And in the war years, | 15:41 | |
when 35% of value of stocks went down, | 15:42 | |
it, no doubt, went down. | 15:47 | |
And yet over it's lifetime, it had an extremely good return. | 15:49 | |
And similarly, again we're talking about 20 years ago, | 15:58 | |
if you'd looked at a whole bunch of colleges, | 16:02 | |
you'd have found that the colleges which did best | 16:04 | |
were colleges like Wesleyan. | 16:07 | |
Now, Wesleyan no doubt had a good treasurer, | 16:10 | |
no doubt had some very loyal alumni | 16:12 | |
with some very good ideas, | 16:14 | |
but the major reason why it was doing better | 16:16 | |
for quite a number of years, | 16:20 | |
was that instead of being right there with the mob, | 16:22 | |
with 50% in equities, which was perhaps | 16:26 | |
a typical college figure 20 years ago, | 16:28 | |
they were 80% in equities. | 16:31 | |
Indeed, if you follow the logic of this | 16:34 | |
that 100% is better than 80%, and 80% is better than 50%, | 16:36 | |
because stocks are a great buy, | 16:42 | |
then the fellow who actually went out and borrowed money | 16:44 | |
and leveraged through a margin account or otherwise, | 16:49 | |
who had 130% in equities, he was the smartest fellow of all | 16:53 | |
in terms of presumed average return or mean return. | 17:01 | |
But of course, he'd be an unusual man, a person, | 17:07 | |
if he slept as well at night when he had borrowed money, | 17:12 | |
because when you go into stocks with your own money, | 17:16 | |
you do have limited liability. | 17:21 | |
And the stock can become worthless, in which case, | 17:24 | |
you tear up the certificate and walk away from it. | 17:28 | |
But if you actually are selling short, | 17:31 | |
or as in this case, you are borrowing money | 17:36 | |
and buying the stocks on the borrowed money, | 17:40 | |
then you can find that as the stocks fall | 17:43 | |
to even less than 100% loss on your equities, | 17:47 | |
you are absolutely wiped out and | 17:51 | |
there's no way of giving a stop loss order | 17:54 | |
that will make perfectly sure that you won't in fact, | 17:56 | |
end up with negative net worth, owing. | 18:01 | |
And so, you're in the position of social disapprobrium. | 18:05 | |
You are in bankruptcy or otherwise. | 18:09 | |
Well now, why was it that 20 year ago, | 18:13 | |
one might have given this kind of advice | 18:19 | |
and have a recent story to support it | 18:26 | |
when that is certainly not the case now? | 18:28 | |
The very fact that men of means are reduced | 18:31 | |
to coming to professors of economics | 18:34 | |
for general counsel and advice | 18:37 | |
shows that there is a failure of nerve, | 18:41 | |
and nobody would believe you | 18:43 | |
if you said the wisest thing today | 18:45 | |
is to have 100% of your money in equities. | 18:48 | |
I think the reason for that was | 18:52 | |
that people 20 odd years ago, | 18:58 | |
maybe I should make this all 25 years ago, | 19:02 | |
generally who had lots of money were old enough | 19:07 | |
to remember The Great Depression and | 19:10 | |
the great stock market crash of 1929. | 19:13 | |
The result is that they never really trusted common stocks | 19:17 | |
even when you could buy common stocks | 19:21 | |
at four to 1 price earnings multiples | 19:23 | |
when they were yielding 9% at the same time | 19:26 | |
the gilt-edged bonds were, in those days, | 19:30 | |
yielding 2 1/2%, 3 1/2%, and mortgages were only at 4%. | 19:33 | |
The result was that World War II, | 19:42 | |
and what it had irreversibly done to the price level | 19:46 | |
was not really recognized and built into the marketplace. | 19:50 | |
Now, if what I'm saying now is inconsistent | 19:55 | |
with the random dart hypothesis of the stock market, | 19:58 | |
then I must confess that I'm not a believer | 20:03 | |
in the Random Dart Theory, | 20:06 | |
because I do believe that there are times | 20:09 | |
when the general level of stocks | 20:11 | |
are high and unfavorable and other times | 20:15 | |
when relatively speaking, they are low and favorable. | 20:22 | |
I'm not trying to say that it's easy to discern those times, | 20:26 | |
and it certainly is hard to prove | 20:31 | |
that you're right if you do have such an opinion. | 20:34 | |
And certainly, the methods of proof cannot be those | 20:37 | |
of geometrical and logical demonstration | 20:40 | |
beyond a shadow of doubt. | 20:43 | |
And they can't even be of the empirical type | 20:46 | |
which the physicists can enjoy. | 20:48 | |
That he can say that nobody's going to see the speed | 20:50 | |
of light in a vacuum exceed that of a certain constant | 20:53 | |
or nobody's going to be able empirically | 20:58 | |
to build a perpetual motion machine | 21:01 | |
of either the first kind or the second kind. | 21:04 | |
Well no proofs like that are possible. | 21:06 | |
But in any case, what happened was | 21:09 | |
that just as we were in that period of 20, | 21:11 | |
of 25 years ago when stocks were great buy, | 21:16 | |
the message slowly began to spread, | 21:18 | |
and I would almost name 1953 as the time | 21:22 | |
when it began gradually to be realized | 21:27 | |
that stocks were a good buy. | 21:30 | |
And I traced the great decade increase | 21:32 | |
in the price earnings multiple of the whole array of stocks | 21:38 | |
to that subsequent time period. | 21:43 | |
All this has been documented in some detail | 21:47 | |
by the famous Merrill Foundation Study | 21:51 | |
done at the University of Chicago | 21:55 | |
by Professors Lorie and Professors Fisher | 21:57 | |
and a number of other competent analysts. | 22:02 | |
I may say ironically, and I say this | 22:06 | |
in no sense of criticism whatsoever, | 22:09 | |
that Merrill Study has probably lost a lot money | 22:12 | |
for a lot of people, or at least, | 22:17 | |
it has given rise to lots of dreams of avarice, | 22:21 | |
of how well people were going to do, | 22:26 | |
only to find that their actual experience | 22:28 | |
subjected them to a lot of regret, | 22:31 | |
because let me quote what he Merrill Study showed. | 22:33 | |
It showed that if you started at 1925, | 22:36 | |
and you just sort of bought everything on the board, | 22:39 | |
just throw a dart, or more specifically, | 22:43 | |
put a dollar in everything listed on the financial page, | 22:47 | |
and do this everyday. | 22:51 | |
Sell out each night and go in, in the daytime. | 22:54 | |
I exaggerate just a little on how often | 22:59 | |
you'd have to turn over your portfolio. | 23:01 | |
Then you would do extremely well. | 23:03 | |
And, this includes the period of the crash | 23:06 | |
and The Great Depression. | 23:11 | |
Of course, if you started out in 1929 | 23:12 | |
and then reckoned where you are in 1932, | 23:14 | |
you have a miserable performance. | 23:16 | |
But if you started in 25 and did it all the time, | 23:19 | |
then the average up to 1960, 1965, | 23:23 | |
your average rate of return would have been extremely high. | 23:29 | |
I don't remember all exact categories, | 23:35 | |
but let's say something like 9% per annum. | 23:38 | |
When we reckon these rates of return, | 23:42 | |
of course, we're reckoning them | 23:44 | |
in terms of dividends plus capital gains. | 23:45 | |
Whether you take those capital gains or not, | 23:51 | |
that's the only way to properly make commensurable | 23:53 | |
two different kinds of investments. | 23:58 | |
Well more than that, | 24:00 | |
the best part of this return we're talking about, | 24:02 | |
came in that fabulous period of the 1950's | 24:05 | |
when people were just gradually beginning to become aware | 24:08 | |
that higher price earnings multiples seemed | 24:13 | |
to be indicated for stocks. | 24:15 | |
And the people who became aware of that early, | 24:17 | |
of course, bought at low price earnings multiples | 24:19 | |
and were in a position to sell out as they so chose | 24:22 | |
at high price earnings multiples. | 24:26 | |
Well, a secret cannot be kept indefinitely. | 24:29 | |
And just as the mob went too far in my opinion, | 24:34 | |
in say in the 1953 period in discounting stocks, | 24:40 | |
the mob finally caught up. | 24:44 | |
And by the 1960's, let's say the middle of the 1960's, | 24:46 | |
people had begun to read the Merrill Foundation Studies. | 24:51 | |
By the way, these Merrill Foundation Studies | 24:55 | |
are completely nonprofit. | 24:57 | |
They're not for the purpose of making customers | 24:59 | |
for Merrill Lynch or for any other brokerage organization. | 25:03 | |
They were a truly tax exempt gift with no strings attached. | 25:07 | |
And there's never been the slightest shadow of suspicion | 25:15 | |
that the computer studies made | 25:19 | |
were anything but completely objective. | 25:22 | |
When you finally begin to get the belief | 25:27 | |
that you could coin things, easy money, | 25:30 | |
by good stock market selection, | 25:35 | |
and a lot of people of course, | 25:38 | |
thought they could do better than the random dart, | 25:40 | |
and you had the performance cult developing | 25:44 | |
and the so called gunslingers. | 25:49 | |
Now the young people really in the saddle, and they thought | 25:51 | |
that they could spot Kentucky Fried Chicken early | 25:55 | |
or Ling early, or other growth situation | 25:58 | |
when they still had low price earnings multiples, | 26:02 | |
and that they would be able to sellout | 26:05 | |
at high price earnings multiples, and | 26:07 | |
that they would be able to recognize | 26:09 | |
early rapid growth, earlier than other people. | 26:10 | |
It became so widespread that every pension fund | 26:15 | |
began to increase the percentage it had in equities. | 26:18 | |
And the typical pension fund, | 26:21 | |
and I'm sorry to say this still tends to be the case, | 26:22 | |
kids itself that there's 9% let's say to be made | 26:26 | |
in the standard way, by a stock market pension fund | 26:32 | |
or even by a balanced pension fund | 26:37 | |
and with a little extra cleverness | 26:39 | |
for which they're prepared to pay, | 26:42 | |
and you could really afford to pay, they'll make 11%. | 26:44 | |
And therefore, it won't cost the company so much. | 26:47 | |
Well, the truth of the matter is, | 26:50 | |
and this is the first thing that one should realize, | 26:53 | |
when one studies the batting averages | 27:00 | |
of all the groups in the market, | 27:03 | |
when one studies all of the methods proposed for investing, | 27:05 | |
one realizes that there are almost no people, | 27:12 | |
and I don't care whether you're in the biggest banks | 27:16 | |
or whether you're in the most successful mutual funds | 27:19 | |
of the last half decade, there's almost no group | 27:23 | |
which systematically can beat the comprehensive averages. | 27:28 | |
In other words, if you were to simply buy all the shares | 27:35 | |
that are outstanding in the New York Stock Exchange, | 27:40 | |
the American Stock Exchange, | 27:42 | |
and let's say the over-the-counter market | 27:43 | |
where at least the stocks are of a certain size, | 27:47 | |
you would find that such a portfolio | 27:49 | |
would do as well or I dare to say, better than 99 out of 100 | 27:55 | |
of the best money management groups in this country. | 28:04 | |
Moreover, you wouldn't use a crude comparison | 28:08 | |
of where you started in say 1960, | 28:12 | |
and where you ended in 1965, or where you started in 65 | 28:16 | |
and where you ended in March 1974. | 28:19 | |
A clever person, an informed person, | 28:23 | |
would correct for risk. | 28:26 | |
And if the market's going up | 28:28 | |
and a person is very risk-taking, then obviously, | 28:29 | |
by borrowing or by buying volatile and risky stocks, | 28:32 | |
he can get a better arithmetic mean of return, | 28:35 | |
but at the expense of a greater standard deviation | 28:39 | |
of dispersion and of risk. | 28:43 | |
And there are lots of methods | 28:45 | |
which have been pioneered in the finance departments | 28:47 | |
of business schools of this country | 28:51 | |
that correct for the differential amount of risk. | 28:53 | |
So, I think the first lesson, | 28:59 | |
and in a half an hour one can't really do better | 29:02 | |
than to go into the first lesson, | 29:06 | |
is a lesson in humility. | 29:08 | |
We don't know what the proper fraction | 29:11 | |
of a prudent portfolio ought to be in equities, | 29:15 | |
but playing safe, it will be some fractional number. | 29:19 | |
Some fractional number in equities | 29:22 | |
and some fractional number in fixed principle assets. | 29:24 | |
We have no reason to believe that by cleverness | 29:28 | |
or by spending money on security analysis, | 29:33 | |
we will be able to do better | 29:36 | |
than the comprehensive averages. | 29:39 | |
This means, my time is now running out, | 29:42 | |
that we're long in need of a reform | 29:44 | |
in which the ordinary citizen of small means | 29:49 | |
or of large means is able to buy a prorated share | 29:53 | |
of all there is outstanding to buy. | 29:58 | |
Let's say a no-load mutual fund, a no management fee | 30:01 | |
or low management fee mutual fund, | 30:06 | |
a low commission mutual fund which simply invests | 30:09 | |
in the Standard and Poor 500 Index. | 30:14 | |
Now, I mention that because it's a pretty good approximation | 30:17 | |
to all there is to hold. | 30:21 | |
But of course if we really had this, | 30:23 | |
then it could invest in all there is to hold | 30:26 | |
and go beyond The Standard and Poor 500. | 30:29 | |
Moreover, this is something which is available | 30:33 | |
to a person with 20 billion dollars. | 30:35 | |
Now why is that? | 30:37 | |
Well suppose that you have your | 30:39 | |
20 billion dollars in IBM and Xerox and Avon and Polaroid | 30:40 | |
and the so called one-tiered stocks, | 30:45 | |
and you should, God forbid, change you mind | 30:47 | |
and decide the prospects weren't so good for one of those. | 30:50 | |
Obviously, you cannot sellout without depressing the price. | 30:54 | |
Whereas, if you own a little bit | 30:58 | |
of everything there is to own, even with 20 billion dollars, | 31:00 | |
you will be in a very liquid position. | 31:04 | |
I want to bring this discussion to a close. | 31:07 | |
Obviously, the problem is not for people | 31:09 | |
who have 20 billion dollars, | 31:12 | |
but I think there is a clear moral. | 31:13 | |
That fraction of your wealth | 31:16 | |
which ought prudently to be in equities, | 31:21 | |
ought to be in a diversified list of equities, | 31:24 | |
acquired by you with low-load or zero-load, | 31:31 | |
and so widely diversified | 31:35 | |
that no expensive management fee is payable. | 31:40 | |
A good test of performance | 31:46 | |
would be a very low turnover ratio, | 31:48 | |
because all the money that's paid out to brokers | 31:50 | |
according to the facts of experience, | 31:55 | |
if you believe in the safety in the total market, | 31:58 | |
is a dead weight loss. | 32:05 | |
Moreover, it's a dead weight loss where it hurts the most. | 32:08 | |
Namely, it comes out the capital gains part | 32:11 | |
of the portfolio, the likely tax part of the portfolio. | 32:14 | |
Well, I think there's a very important lesson | 32:18 | |
to be learned there. | 32:23 | |
I want to go on to say that I've given this sort of advice | 32:24 | |
for handsome fees to some very important investors. | 32:28 | |
But I always tell them this is advice you will not take, | 32:33 | |
and I've very rarely been proved wrong. | 32:37 | |
- | If you have any comments or questions | 32:41 |
for Professor Samuelson, address them to | 32:42 | |
Instructional Dynamics Inc. | 32:45 | |
166 East Superior Street, Chicago IL 60611. | 32:46 |
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