Popular Science Monthly/Volume 28/November 1885/The Art of Investing
|THE ART OF INVESTING.|
"HOW can I invest my money to make it pay a fair interest, and at the same time insure its safety?" is a question daily asked by thousands. With the multiplication, consequent upon the growth of wealth among us, of that class of persons who want to live by their means, without care or labor, the number of anxious inquirers on that point is constantly increasing. It would seem, when reference is had to the many securities, both bonds and shares, that are offered, often at temptingly low prices, to be a question very easily answered. The truth is, there is none more difficult. The ordinary investor who goes about the work of converting his cash into paper combining the two elements of value spoken of, finding himself hopelessly embarrassed by the seeming richness of the market, soon gives up in despair, and turns the job over to some banker or broker who works for a commission. Experience shows that even then he is too often the victim of defective judgment or misplaced confidence.
A history of investment securities would furnish a most interesting study. In no other department of business have there been greater changes. The time has been, within the memory of many now living, when the man who had money to put at usury, generally loaned on personal indorsement, the borrower relying on his neighbor or other good friend to "back" his paper for him. The mortgage on real estate, of course, was known; but, owing to the short intervals for which loans were usually made, was not often resorted to. The shares of banking, turnpike, canal, railway and other incorporated companies after a while began to absorb the money of people who wanted to realize more than current rates of interest, and were willing to take corresponding risks.
The war of the rebellion popularized the coupon bond, in consequence of its adoption by the Government, and made it the favorite form of investment paper. Railroad and other corporations lost no time in availing themselves of the confidence which that species of debenture inspired, and States, cities, counties, etc., were soon flooding the country with obligations carrying long coupon attachments. Except for government and municipal uses, there never was a more disastrous invention. It has been the means of numberless deceptions, and has inflicted heavier losses upon the investing public than all other devices combined. Being supplemental to stock certificates, it has duplicated representatives of the same values and led to excessive issues of paper; it has separated capitalists from the management of properties into which their moneys have gone; and, being based upon mortgages promising absolute security, it has too often accomplished the grossest deception. Many a man has purchased and paid a good price for a mortgage coupon bond, giving him no control over his security, who would have rejected a share-certificate standing for an equal interest in the property pledged, and giving him the right to participate in its management, with the possibility of a greater return for his money.
Under the careless legislation of many of the States, which has permitted corporations to decide for themselves the amounts of obligations they might put out, it is no wonder that the privilege has been abused, and the making of shares and bonds, the latter represented to be amply secured by mortgage liens, has been carried to criminal excess. One illustration will suffice. The Arkansas Central Railroad Company (the name indicates the locality) built only forty-eight miles of its projected line. The road was of narrow gauge, with very light iron, and in every way cheaply constructed. It cost less than ten thousand dollars per mile, including equipment. As with most companies building railways in new countries, help in its behalf was asked from the communities to be benefited, and bonds amounting to nearly half a million dollars were given it by counties, cities, etc. Under a statute providing for aid to railroads when their beds could be utilized for levee purposes, the company got $160,000 of State bonds. Under another statute, it got, as a loan from the State, its bonds to the amount of $1,350,000, which were to be a first lien upon the property. After such abundant assistance, it would have seemed hardly necessary for the company to put out obligations of its own. However, it proceeded to issue and market its own bonds to the amount of $2,500,000, of which $1,200,000 purported to be secured by first mortgage, which was not the case. In addition, a considerable amount of stock certificates was issued. Altogether, nearly $5,000,000 of paper were put out and negotiated on the basis of forty-eight miles of narrow-gauge road. But this proved to be insufficient. The road, for non-payment of interest, soon passed into the hands of a receiver, who found it in such an unfinished state that, with the court's permission, he issued a considerable amount of his own certificates to provide for necessary repairs and betterments. Then the road—the product of so much outlay—was sold at public auction, and brought the magnificent sum of $40,000, which was paid, not in cash, but in receiver's certificates that had been purchased at a large discount!
That the foregoing case was not a solitary one, nor so exceptionally bad, might be inferred from the fact that the president of the railroad company, who managed its business, and was understood to be its principal beneficiary, was afterward elevated to the United States Senate, and is said to have been offered a seat in the Cabinet of one of our Presidents.
The business referred to has not been confined to railroads. We now have stocks and bonds upon the market representing nearly all conceivable kinds of property—telegraphs, telephones, mines, cattle ranches, grain and grass farms, water-works, electric lights, factories and mills of every description, steamboat lines, and apartment-houses. There seems to be no limit to their production. There never was a time when it was so easy to invest money—and to lose it. Of the securities that are offered with first-class recommendations, it is probable that about one third are actually good, one third have some value, and one third are practically worthless.
For the condition of things described, the laws of our States, in giving corporations almost limitless power to issue negotiable paper, are, undoubtedly, very largely to blame. Our banks are closely watched and restrained from taking people's money on false pretenses; but how much better is it for railway and other corporations to take it by means of legalized fictitious evidences of value? Banks are by no means the only corporate institutions that need watching. One of the reforms that would seem to be very much demanded is legislation that will prevent companies existing by authority of law from putting out debentures or scrip not represented by money actually paid into their treasuries, or by proprietory interests whose value is to be determined by disinterested parties. Pennsylvania has incorporated substantially such a provision into her Constitution. Her example should be followed by all other States.
For the losses they have sustained, investors, as a rule, have themselves chiefly to blame. The mistake made, in nine cases out of ten, has been the purchase of cheap securities. The hope of realizing a little more than ordinary interest, by buying paper at a discount, has proved to be the rock on which unnumbered capitalists have split. In addition to their money's worth, they have endeavored to get something for nothing, with the result, most generally, of getting nothing for something. It is remarkable how blind are people, ordinarily sagacious enough to make money, to the fact that property can not pay a revenue beyond its producing capacity. For instance, how can a railroad company, whose line is wholly or mainly built from the proceeds of mortgage bonds, sell them at a heavy discount, besides allowing large commissions for selling them, and then pay a high rate of interest on their face?
But for the losses referred to is there not too often somebody else to blame? The seller of investment securities is usually not the maker of them, but a professional middle-man known as a broker. The extent of his responsibility is a very interesting question. Is he justified in assuming that caveat emptor is the rule that is to govern; or is it incumbent upon him to inform himself as to the true character of the paper he offers, and give his customer the benefit of the knowledge he acquires? In other words, does he not, by virtue of the relation he bears to the purchaser, which is ordinarily one of confidence, become, morally at least, a sponsor for what he sells? In view of the millions of trash that have been unloaded upon the public as solid investments, of the true character of which it would not have been difficult for any one making a business of handling paper to inform himself, it is hard to reach any other conclusion than that there has been very great laxity on the part of many who, under the plausible titles of banker and broker, have made the selling of securities an occupation. It will hardly suffice for them to say in defense that they sold the paper at market prices. They should have known that the value of what they sold bore a reasonable approximation to the price that was paid. If they did not know it, and could not ascertain the fact, they had no business to dispose of the property. Manifestly, a higher standard in such matters should prevail, and the way to secure it is to hold those who professionally market investment securities to a far more rigid accountability than has heretofore been insisted on.
By what rule or rules is the investor now to govern himself? No formula can guarantee him absolute safety. One thing, however, he can properly count upon, viz., that he must expect to pay a fair price for a good security—one that will return him no more than a moderate interest on his money. If he wants to speculate, and is willing to take risks, that is another thing. He can then look for bargains. But there is such a thing as going too far in the matter of prudence. The investor may pay too dearly for safety. There are securities which, compared with others that are to be had, sell at prices much above their real value. The reason is that they are universally known to be good both as to principal and interest; but there are plenty of others, that may be had at lower figures, which are just as good. There is no reason in the world why the investor should not get at par all the paper he wants, that will yield him six per cent interest, and be as safe as any property can be under human supervision. In making the selection no more judgment is demanded than in purchasing lands and cattle. Two very common and often fatal mistakes should be avoided. One is in relying solely upon the advice of a broker. By far the greatest number of losses to investors has been in securities purchased exclusively on the recommendations of interested commission-men. While it is well to get the opinion of a reputable broker, the purchaser should investigate and decide for himself. The other is in giving a preference to "listed" securities. Many persons seem to think stocks and bonds must have a value if they are quoted at some stock exchange. On the contrary, such a position is likely to expose them to manipulation for purely speculative purposes. Stock-exchange quotations, as a rule, are unsafe guides to buyers. Every security must stand on its own merits, and purchasers have merely to follow business principles as taught by the canons of common sense.