What every investor ought to know

Contents

CHAPTER PAGE

I. Knowledge vs. Chance — The Investors'

II. Protecting Dependents— The Will— Trust

Preface

THE chapters constituting this book were published in various issues of The Magazine of Wall Street by the author under his pen names of Arthur N. Slocum and James Kennedy.

Almost all books written for the investor are both technical in language and dry reading. These articles are set forth in the simplest form and fictitious names and situations are used to attempt to make the chapters more interesting to the reader. The author hopes that the casual investor will apply such instances to his own case and thus make the book profitable throughout.

It is a strict rule of The Magazine of Wall Street — wherein these chapters appeared — to only publish articles which are easily understood by every reader and whose context has an actual concrete value to the reader. This summary of

6 PREFACE

purpose has been attempted in each chapter. It may be that the reader will not at first appreciate the continuity of financial education set forth in each chapter, but these chapters are an incentive for further study and each one contains a text which may be enlarged upon at the will of the student.

The elementary features of What Every Investor Ought to Know may be found in this book. Do not try to read it through at one time. Read a chapter at a time and then take up the supplementary reading applying to this particular chapter. The reader will find that it will be very profitable.

Robert L. Smitley.

WHAT EVERY INVESTOR OUGHT TO KNOW

CHAPTER I Financial Knowledge Versus Chance

Investor and Speculator — What the Classes Mean — What to Avoid

KNOWLEDGE spells Success. This aphorism is becoming commonplace, but its truth cannot be controverted. Especially is this true when it refers to dealings in the security markets. The differentiation between the terms speculator, underwriter, investor, reorganizer, and promotor is usually pronounced in the minds of all those who are acquainted with the terms, but when the actual definition is called for, the dividing line is blurred and indistinct. There is but one psychological dividing line. The above phases of the security business stand on one side and the simon pure chance-taker stands on the other side.

The Chance-Taker

This class of operator discards the fundamental basis of the speculator or investor, which is knowledge. His tools are Luck and Tips. The books of a fair sized, or large brokerage firm could easily be divided into the two classes, if one took the time to investigate each customer. The writer, at one time a partner of a brokerage firm, was interested to a sufficient extent to make such a test. There were about three hundred active accounts of individuals in the ledger when the list was taken. Twenty-five per cent of these were, without doubt, gamblers and the rest speculators and casual investors. At the end of three years, ninety per cent of the gamblers had disappeared. Their names were no more to be found in the ledger. Not more than ten per cent of the other class was lost to the business. It was a clear case of Science versus Luck, with Science the winner in nearly every instance.

Psychology of the Gambler

The chance-taker has no plan of campaign. He is a creature of the moment much as a butterfly in the animal world. The world is scientifically ruled and there are inviolate mathematical rules to fit the gambler in any game. The chances are always against him and when this element of mathematics is supplemented by superstition, the chances for his failure are enhanced. The word Superstition is used in much the same manner as the word Luck is used. Both eliminate all consideration of the knowledge element.

This superstition feature is the most ridiculous of all the elements which tend to formulate the gambling character. It would be as impossible to list all the superstitions as it would be to reach the nth power. One man trades in U. S. Steel com. because in the past it has been his luckiest stock ; a second always sells stocks when Trinity Church chimes are playing a hymn; a third believes that prices fall on Tuesdays more than any other day of the week ; a fourth always sits in a certain chair. The list could be continued until it would become tiresome, if it were not tragic. Human beings are all imbued with a certain degree of superstition, but the man who can trade his superstitious leanings in business for a modicum of real knowledge is just that much ahead of his former kind.

"Tips" are the second worst tools of the chance-taker. They are even more dangerous for the user than his superstitious qualities. The rational man would consider the reason for a "tip." In the realm of finance there is no sentiment. Each man is primarily for himself. It is the law of nature and the "tipster'' is the man who offers advice without a basic reason for giving it. He may have a private and a very personal reason, and it is true that "tips" often are productive of gains, but only when the recipient acts at once and takes his profit, if any, when it appears, without the slightest delay. Daniel Drew, the most famous of the "bears" of former days, dropped a small piece of paper on the sidewalk as he left his carriage to enter his office. A by-stander picked it up and read, "Buy 5,000 Erie at the market." Without doubt, this order was meant for Drew's broker and the loss was an accident. Within fifteen minutes every gambler had the word to Buy Erie. Of course Drew created an excellent market for his sales that particular morning.

Advice versus Tips

It is the one purpose of legitimate brokerage firms, investment houses, news agencies and market advisers to retain their followers. To do t|iis they must advise in such a manner that they are right more often than they are wrong. The gambler refuses to accept the experience and knowledge of good advisers, whose sole business is to study the security markets from every viewpoint. He prefers the excitement of following his superstitions and tips. The result is inevitable failure.

Good advice and purchased assistance for the purpose of dealing in securities is even more necessary than in the commercial world. The Business of Trading in Stocks is more difficult than any other form of business, and it is unfortunate that so many will not appreciate this fact until they first burn their fingers in the fire. From the psychological point of view, the requirements, in addition to sufficient capital, are Knowledge, Study, Good Advice, smooth running machinery and above all a firm, brave temperament, so different from that of the gambler.

The Speculator

The limitations of this article are too confined to list the resources of the successful speculator. Primarily, however, he must have an intimate knowledge of what the Trend of the security market is as shown both by the prices — the "tape," to use a technical word — and exterior commercial and financial influences. These in turn may be influenced by political and sociological conditions. There are plenty of excellent books on this subject and there is at least one service in existence which will assist the speculator. Our study is the man who has taken advantage of such opportunities.

Cornelius Vanderbilt, Leonard W. Jerome, Anthony W. Morse, Jay Gould, and on down to men of today, such as Bernard Baruch, are types of successful speculators who have bettered the world through their success. The "constructive" speculator is the very best asset which any country can have. His acquired knowledge teaches him that the efforts which tend toward the improvement of mankind are the only dependable speculative efforts. The knowledge acquired by Mr. Baruch through speculation in industrial securities made him one of the most valuable men for this country on the Board of National Defense. The speculative knowledge acquired by the late E. H. Harriman in railroad securities caused the Union and Southern Pacific systems to open up a country which will possibly supply the nations of the earth with food. If Mr. Harriman had been but a chance taker, he would not have achieved what he did. If he had been but a careful investor and had not studied and planned, the result would have been somewhat the same as the gambler's so far as his fame is concerned.

Required Temperament

To plan out a campaign just as the General of an Army does, is the necessity of the Speculator. It is said that Germany had every move of war mapped out in advance when the rush was made through Belgium. An unexpected check was given to these plans at the very start, and they had to be at once revised to meet the new conditions. It was absolutely necessary to have the original plans, even though they were later altered. The analogy applies to the speculator. He maps out his course after study, advice, retrospect, and outlook. Once determined that he is right, he irioves forward with his campaign. There must be no cowardice, but sometimes there must be quick decisions and retreats. The old campaign type of speculator does not consider one reverse or one false move the end of his efforts. He fights on until either victory or defeat is effected. If his knowledge is better than his opponent, victory is assured, but he always provides a safe line of retreat and makes certain that his commissary department — his capital or margin — cannot be entirely destroyed.

The successful speculator may spend all his time with his broker, may be a broker, or he may devote the surplus from gains derived from another business and speculation may be only an avocation. In any event, he will follow his own judgment supplemented by the best advice he can buy; his temper will not sway his purpose; his nerves must be trained to stand sudden shocks ; and he will not be influenced by superstition or worthless "tips."

The Investor

In following out the psychological trend the Investor is classed a grade or two higher than the Speculator. Why this is so it is hard to determine, but the man who Does Business in Stocks and Bonds is much better satisfied to be termed an Investor than a Speculator. If the economic status is carefully examined, it will be found that the Speculator, as he is defined in our minds, does much more for mankind than the Investor, although each has his place.

The Speculator's efforts in the broader sense affect the whole community. His work helps to build up new industries, creates new positions for workmen, starts new cities and stimulates all commercial endeavor. Without the speculator in United States Steel stocks, we would not have the remarkable resources which we have to assist us in this World War. We would not have the City of Gary, Ind. Had Mark Twain not lost all his money trying to support a type-setting machine, we might not have had the Linotype and its kindred forms of machinery.

Nearly every man and woman has become Investor. But the Investor requires nearly as much knowledge to succeed in his purpose as the Speculator. He does not realize this fact so thoroughly as the Speculator, but he is fast coming to realize it. The old type of Investor was the head of a family living in Rhode Island who, after making $100,000, "invested" it all in New York, New Haven and Hartford Railroad stock, so that his family would never want. He felt so certain of his investment that he willed it to his heirs in such a manner that it could not be sold. He considered a broker's office as equivalent to a gambling hell and he smugly died with the knowledge that he had done his part in the world. His widow is probably running a boarding house and his children clerking or stenographing in a broker's office. He was one of the type so aptly termed, in The Magazine of Wall Street, a "Sleeping Investor."

Honore Balzac, in his Comedie Humaine series, considers the genus "Old Maid" as an economic loss to the world. If he had lived today, he would probably have classified "The Sleeping Investor" the same way. The successful Investor must be as active and up-to-date as the Speculator if he is to retain his Income and Capital. He will have his Investments examined by experts periodically just as he will go to his dentist every few months, or be physically examined by his family physician. He knows that it is his duty to take out Life, Health and Fire Insurance, but he also knows that he cannot keep up the premiums on his Life, Health and Home unless he insures his Income and Capital.

The Investor is organizing. We already have two or more organizations comprising railroad share holders and it will not be long until the industrial share holders will come together under some capable leader to ask for uniform reports or some other excellent feature of co-operation. The Investor is gradually awakening and the meaning of his name is becoming confused with the definition of the Speculator.

The Investor has found out that it is necessary for him to keep in touch with events and happenings if he wishes to protect and increase his funds. The habitual bond buyers have also reached the same conclusion. The man who once purchased Rock Island Co. collateral 4% bonds due 2002 at 60 or 70 and put them in his safe deposit box, forgetting he had them, learned some short time ago for the first time that the total equity to which he was entitled after the downfall amounted to a problematical $100 or so for each bond costing between $600 and $700. When he gets his next surplus, and invests, the investments will be analyzed.

CHAPTER II Protecting Your Dependents

Your Will — Executor — Trust Funds — Ante- Mortem Preparation

HAVE you made adequate preparation to safeguard your family or dependents in the event of your death?

This is a subject which is not by any means a pleasant one to discuss, but it is one of the most important matters for every man to know if he desires to protect those who are dependent upon him. There is a certain amount of hesitancy in attending to these items, because no one desires to think of the possibilities, but it is the unselfish, careful man who does think of and attend to such matters, and no one enjoying the finer qualities of mind and sensibility desires to be classed with the selfish and inconsiderate.

There are three distinct steps to be taken in making such arrangements : the first is arranging the estate, no matter how small, so that it may be easily handled for the best interests of the heirs ; the second is placing of the increments of the estate in such a manner that the beneficiaries, even during the life of the owner, are able to derive full benefits with the least risk; and the third and most important step is the matter of the will and the executor.

The Investments

Taking into consideration the fact that the ow r ner of an estate which will ultimately be used for the purpose of giving income to dependents, desires it to fulfill the original purpose, there are three important items for careful consideration.

The first item is to have the various increments invested so as to bring a good return with more than reasonable safety. With the exception of owning a home, property is not the most desirable element to consider. However, if the home exists during the life of the husband and father, it should be one which can be kept up from the income derived from the remainder of the estate. It should certainly not be encumbered with mortgages or any kind of a lien. It would be far better to dispose of all equity in even home property and arrange for rental, if there is the chance of dependents falling heir to encumbered property (real estate).

Having arranged to make the homestead free from all possible encumbrances, the next step is to make the investment. These investments should not be allowed to yield much over five and one-quarter per cent. If the flat yield does go over this figure, it is very possible that there may be one or two items which will be liable for total loss and thus decrease the income. A reasonable arrangement is this (basing the total value of the estate at $20,000) :

Home and property unencumbered $ 4,000

Actual cash in Trust Co. 2% interest 1,000

Guaranteed mortgages, 5% 5,000

Real first mortgage, R. R. bonds, 4}4% 5,000

Real first mort Industrial bonds, 5% 2,500

A good list of preferred stocks, S T / 2 % 2,500

The cash in the trust company should be a liquid reserve fund to meet any unexpected contingency. It should never be touched unless in a case of absolute necessity. The trust company is the best depository for such a fund, because it gives the depositor a better rate of interest, and is just as safe as any other form of banking. It would be best to have the deposit in one of the larger trust companies of the nearest large city. The local National bank could be used for depositing the income and for a checking account.

The guaranteed mortgage should be one of a duration of not less than ten years, and backed by the best title and guarantee company available. It is well to investigate the actual property on which the guaranteed mortgage is a participation whenever possible, but if the guarantor is well known as reliable, it is reasonably safe to accept his word for the basis of the mortgage. This kind of a mortgage permits the owner to be free from all complications of a legal nature.

The real first mortgage railroad bonds are differentiated from so-called first and refunding mortgage bonds. A bond like Iowa Central 1st and refunding 4 per cents, would never do. The name is a misnomer, for the first mortgage consists of a very small proportion of mileage and the first lien on a bridge. The help of a good financial service and also of a trust company should be called in to judge this item of the estate as well as all other iterr^s mentioned.

The first mortgage industrial bonds are classified similar to the Central Leather Co. 1st 5 per cent, bonds, or the Bethlehem Steel Co. 1st 5 per cent, bonds. There are very many excellent examples of this form of investment, but the investor must be very sure not to be deceived as to the bonds being a first lien and having the backing of the entire resources of the corporation.

The preferred stocks should be chosen from the tried field. Not only should the past history of the company be investigated in a thorough manner, but the record of dividends over a period of years and a complete study of the outlook for the future should be made. Good investments in the railroad field such as Atchison Preferred and Union Pacific Preferred or even in the Industrial field such as U. S. Steel Preferred or National Lead Preferred are examples of this particular form of investment.

An alternative of a very safe nature would be to substitute one of the Government (Liberty Loans) for a first mortgage bond of the railroad variety. The investments should not be made in more than $1,000 in each kind of railroad bonds or more than $500 in each class of industrial bonds and preferred stocks (on the $20,000 basis). Attention should be given also to a thorough geographical distribution so as not to have the liens covering one locality.

How to Make It Easy for the Beneficiary

If the father or husband in going to fight for his country and the expectation of his return to his dependents is doubtful, or even if the estate is to be arranged for easy liquidation after death, there are important steps to be taken.

Should the owner be a resident of New York State he must take into consideration the law . which places a tax on all bonds. The bonds should be made tax exempt by paying the costs at once. This covers a period of five years. Should the bonds not be made tax exempt the State authorities will step in when inventory of the estate is taken and charge a large interest item in addition to the regular tax involved.

Each share of stock should be endorsed in blank and properly witnessed and dated. In the event of the owners' non-return the stock will not have to be transferred for sale or to go through endless red tape to have the dividends go to the proper parties.

The bonds should be registered as to principal and interest whenever possible, and the owner should furthermore make out separate bond powers in blank, having them properly dated and witnessed in the same manner as the stock. The guaranteed mortgage could easily be made out to two parties so that in the event of the death of the head of the family the proper beneficiary would have little difficulty in acquiring the full title.

During the life of the family head, the item of cash in bank should be to the credit of a joint account so that no embarrassment w T ill come to the heirs when the need of the "rainy day" surplus comes. Without question the homestead should be placed in the name of the one to whom it is destined ultimately to go. There are no other means to get away from legal red tape unless this idea is fully carried out.

An Alternative

If for any reason the head of the family about to depart for war or in arranging his ante-mortem affairs does not desire to go so far in these safeguards, there is the alternative of using the services of the trust company. Any trust company will help conserve the total property during the lifetime of the owner by creating a trust for one's own benefit. This trust can also be extended for the benefit of the family after death. The trust company takes entire charge of all the property at a very nominal sum and will do all the work of collecting and disbursing the income both during the absence of the head of the family or in the event of his death. There is no limit to the kind of trusts which may be created, so that there is no excuse for the head of the family not taking advantage of this form of protection.

In addition to this, it is possible for the trust company to safeguard all the increments of investment during the life of the principal, without creating a trust. Such a form of procedure permits the father or husband to invest with a little higher rate of interest than that allowed under pure trusts. The company will keep these investments in a private vault, collect and disperse all items of income, and, furthermore, look after the individual securities so that they will not lose from improper watching.

It is difficult to overestimate the value of the trust company's services under such conditions.

Keep Records

A complete list of all securities owned by the estate should be left enclosed with the will and another copy given to the principal beneficiaries. In this way there exists a complete check on the estate and a safeguard against any crooked dealing. The deed for the homestead and all receipts denoting that taxes have been paid to date should be a part of the contents of the safe deposit vault or go to the trust company handling the business. The deed must be entered on the county records and all papers relating to the insurance of the title to the property or fire insurance on the home should be attached. A personal property inventory of effects belonging to the household showing the location and original cost should be a part of the records, for this is a very necessary item of proof for collection in case of fire.

An Executor

A trust company is a thousand times safer than an individual for the purpose of conserving the estate, either on the basis of trusts while living or executor duties after death. The trust company cannot charge more than the legal rate for such duties and in addition to this feature there is no possibility of undue risks such as arise in a one man trust proposition.

The head of a family often has a close friend in whom he has implicit confidence. He thoroughly believes that this friend will do more for his dependents than a trust company. He does not take into consideration the personal element which exists wherever the individual is concerned. This element is that, because a man is human, he may be swayed by ulterior influences even if under bond to protect the estate. This friend may become seriously incapacitated mentally or physically. He may die soon after or before the family head, or his personal affairs may become so pressing that his time is not given to the interests of the estate or trust which he controls. It is neither doing the heirs or dependents a favor, nor is it doing the trustee or executor a favor to put him in this position.

The employment of a trust company in the fiduciary capacity is the only rational method of procedure. The trust company performs its acts strictly in an impersonal method, under stringent laws of control and through committee decisions.

Two heads are better than one and two or more experienced heads are infinitely better than one possibly very inexperienced head.

Eliminate Legal Items

In addition to the care in selecting a competent trustee or executor, the warrior about to leave for probable death must try to eliminate as many legal complications as possible. There is nothing which will eat up an estate so quickly as to get it tangled up with law expenses. There is certainly a place for the legal element in our worldly afifairs, but the more the law and lawyers are kept away from an estate or trusteeship, the greater is the a'mount conserved for the dependents. The trust companies all maintain legal departments, which service comes under the regular expense of administration. The extras are done away with and the costly red tape is prevented to the distinct advantage of the beneficiaries.

The Will and the Executor

Every man without exception should make a will. If he dies without a will the law steps in with all its costly features and regardless of the actual needs of the heirs, settles according to law and not according to reason how the estate should be divided. There are set rules for the division of an estate when the owner dies without a will. In addition to this it is the usual custom for the courts to appoint the administrator who is nearest of kin without much regard for his or her ability to administer. In this way much money, both from income and principal, is lost. By all means do not neglect to make a will if it is your desire to give those dependent upon you the full benefit of what you wish them to have.

Make the will just as short as possible. The more words used in a will offer greater opportunities for ambiguity and therefore legal complications. If the testator can compress the will into one or two simple paragraphs, there will be a greater chance for the will to stand.

One excellent method is to place the investments in the names of those to whom the will directs they shall go, before the death of the head of the family. Such beneficiaries may sign the certificates in blank or give unfilled-in powers-of -attorney for the bonds. The investments are therefore negotiable during the life of the owner, though not in his name. If you own 5 shares of Atchison preferred stock and desire it to go to your wife, Jane Smith, after you die, so designating this amount in your will, have the transfer made, at the time of purchase, to Jane Smith. Jane Smith may then endorse the certificate in blank and it is usable for your own purposes during your life and you may sell or change your purpose at any time, for the stock has been made negotiable.

Either have your own lawyer draw your will or have the trust company do it for you. Do not attempt a holographic or home made will. The law has a language all its own and the layman is absolutely unacquainted with it. A number of years ago one of the justices of the Orphans' Court of Pennsylvania drew a full and complicated will. He had been passing on the valid- - ity of wills for years and yet his own will was easily broken. Very few doctors can cure their own diseases and very few lawyers can do their own legal work. It is therefore best to follow the plan of brevity and clearness if it is your desire to properly safeguard your dependents.

What an Executor Must Know

Above all else do not make a relative, or any other single person, whether friend or lawyer, the executor of your will. Here are a few "qualifications for an executor" suggested by H. A. Blodgett in his pamphlet of that name: Real estate values, the true value of various classes of securities, the trend of the money market, the laws and ordinances affecting property, including the Federal Income Tax Law, the Inheritance Tax Law, the Exempting of Bonds and Trust Funds. He must also have a good knowledge of reports constructed in legal form, bookkeeping, and legal accounting. He must be a man of keen knowledge and experience and he must not have any partiality for one heir over another. In fact, the foregoing are but a few requirements for a mediocre executor. Why not be on the safe side and employ a competent trust company in the first place?