The stock market is a giant distraction machine that drives investors to act against their best interests. The daily price swings. The clickbaity headlines. The 280-character hot takes on social media. Every bit of it feeds speculative urges and subtracts from long-term success.
What does matter? Timeless investing principles exist to remind us of the simple concepts that drive success. Focusing on the long run, avoiding excessive risks, keeping costs low, limiting the number of trades, and understanding what’s in your portfolio are examples of common sense ideas that have kept investors out of trouble for a few centuries.
A case in point is a list of investment principles by Morrell Walker Gaines in his 1922 book, The Art of Investment, that could have been written yesterday. He intended for the book to be a foundation for the average investor to learn from and build off.
What’s interesting is that Gaines had similar beliefs as Ben Graham. His seven principles are based on value, prioritize investment over speculation, and proposed that investing should be treated as a business.
These principles are based upon the rotation of values and upon investment for the long pull.
1. The first principle is that business will come back. It will neither remain depressed nor exalted.
2. The second principle is that security prices are finally governed by the course of business and the related changes in credits. The extremes of high and low in stocks are displays internal to the market and are ironed out after a time by stronger external forces. It is only in a limited sense that the stock market forecasts business… The ends of market movements, the height and depth of speculation, almost invariably over-run the real trend of business and go counter to the true outlook, because speculative forces have been aroused into motion and have gained a momentum which carries them to extremes. When business changes become too imminent to be ignored, there is a sudden discounting of what should have been gradually discounted before, and a sudden wide change in prices follows.
3. The third principle of investment is that only the upbuilding companies, already strong against storm and depression, are worth investing in. Fairweather companies, weak in the cash box and poor in credit, may serve excellently as pawns of speculation but are false media of investment. It is in the speculator’s sphere to take chances of bankruptcy in return for chances of making quick profits. But the investor wants to take no chances of having to make a fresh start from the bottom.
It is, however, true that this rule of investment values should not be rigid. In time of prosperity, when increased risks can be looked for later, strong companies should be adhered to. In time of depression, after the storm is over and it can be clearly seen that business improvement will lighten risks, it is safe enough and quite profitable to take on second-grade companies, provided one knows they are not in danger of difficulties…
There are times of greater and times of less risks, and there are ways of analyzing and appraising risks and of protecting against them. For most people, and at most times, the simple principle of sticking to investment in solid, progressive companies and first-class securities is by far the best; and of avoiding the dangerous attempt to increase income by purchasing securities of extra high yield. It is quite common for investors to run a disproportionate risk as to principal, which is all that they have, for the sake of an inconsequential increase in income, from holding inferior bonds and stocks.
4. The fourth principle of investment is that the type of securities should be chosen which best suits the purpose of the investor. He should have a definite object in mind and choose a fit security of a fit company. The investor has to run his investments like any business undertaking. If he has all of his money in stocks, which are a proper investment in their place and time, he has subjected himself unreservedly to the major risks of the unexpected changes in markets and conditions…
The investor should have a cash reserve, so that if there is a slump in security prices he can go into action and buy cheap, instead of being put out of action by being loaded up with securities that have depreciated. He also should have a solid substratum of bonds or notes, long bonds if bonds are cheap, short bonds or notes if bonds are high. These securities should be diversified and strong, so that they may bring him assured income through any depression and be available for realizing cash at need, or to buy other securities at low prices.
5. The fifth principle of investment is that the value and the price of a security are to be weighed and the risk of loss set over against the chance of profit. At the price paid the risk should be less than the chance of profit. It is no uncommon mistake to take major risks for minor profits both with bonds and with stocks. The real skill and discernment of investment exhibit themselves nowhere more than in appraising risks. If it can be discovered when and where risks have been exaggerated in the low ness of price, the major profit follows as a natural corollary.
6. The sixth principle to be observed by the investor, partly covered in the preceding paragraphs, is that the phase of business cycles and security prices which determines both value and risks also determines the kind of security to be bought. Each stage of the business progress – prosperity, depression, and transition has its most appropriate type of securities. Each phase of the security market cycle also presents its best types and opportunities…
He is in position to watch the tides of the market, not too closely nor with too much absorption, and to change deliberately from what has become high to what has become cheap; or, if nothing is cheap, then to a Treasury note or some other short maturity that will not decline in price. He can take opportunities as he sees them, governing himself by the long-distance view.
7. The seventh principle of investment, the most general and underlying all others, is that the investor must know all the elements of his investment — the company, the security, the stage of business and of market prices, and the outlook for credit and banking. He must understand. Where he knows, he can invest. Where he does not know, he is only speculating…
Really to know any security requires solid work; to have wide knowledge of securities requires a great deal of work — simple but abundant work. Such knowledge is the basis of sound investment.
The Art of Investment