The Defensive Investor’s Portfolio Policy
•
•Those
who can not afford to take risks should be content with a relatively low
return.
•The
rate of return is dependent upon the amount of effort put forth by an
investor.
•
•As
previously stated,
the defensive investor’s portfolio should consist of no less than 25% high
grade bonds and no less than 25% large stocks.
•
•Yet
these maxims are
difficult to follow, because like the herd of Wall Street, when the market has
been advancing, the temptation is strong to bet heavily on stocks.
•This
is the same facet of
human nature that produces bear markets.
•
•The time to invest in the stock market is after it has
suffered a large loss.
•
•
•A 50% ratio of stocks and bonds was a prudent choice except
during periods of excessive increases or decreases in stock value.
•This
simple formula guards against the mistakes caused by human
nature even if it does not provide for
the best returns.
•Again, Safety
of Principal is Graham’s chief concern.
•
•
•Bonds
•The
decision between
purchasing taxable and tax-free bonds depends mainly on the difference in
income to the investor after taxes.
•Those
in a higher bracket
have a greater incentive to closely examine this issue.
•For
example, in 1972, an
investor may have lost 30% of his income from investing in municipal issues (“munis”) as opposed to
taxable issues.
•
•Bonds
come in many types, a description of which follows.
•
• US
Savings Bonds are
a great choice. In 1972, they came in two series: E and H.
The Series H Bond paid semi-annual interest. Series E Bonds did not pay
interest, but rather sold at a discount to their coupon rate. In 1972,
Series E bonds provided the right to defer income tax payments until the bond
was redeemed, which in some cases increased the value by as much as
one-third. Both E and H Series Bonds are redeemable at any time providing
bondholders protection from shrinkage of principal during periods of rising
interest rates (or rather, the ability to benefit from rising rates).
Both series paid in or around 5% in 1972. Federal, but not state, income
tax was payable on both series. Graham recommends US Bonds due to their
assurance of transferability, coupon rate, and security.
•
•
•Other US Bonds come in many varieties.
•Federal
taxes, but not state taxes, are charged on other US Bonds. Some of these
issues are discounted heavily.
•Others
bonds are guaranteed, but not issued, by the US government. As
of 1972, the US government had fully honored its commitments under
all guarantee obligations. Federal guarantees, in essence, permit
additional spending by various federal agencies outside of their formal
budgets.
•
•State and Municipal Bonds are exempt from federal and state tax in the State of
their issue.
•However,
not all of these bonds possess sufficient protection to be considered worthy of
investment.
•To be worthy of investment, a bond should possess a minimum
rating of “A”.
•
•Corporate Bonds are taxable and offer higher yields than all types of
government issues bonds.
•
•Junk Bonds are those that are less than investment
grade. Their title is aptly given. The investor should steer clear
of these issues. The additional yield that junk bonds
provide is rarely worth their risk.
•
•
•Savings and Money Market Accounts are a viable substitute for
US Bonds. They usually
pay interest rates close to rates paid on short-term USbonds.
•
•Preferred Stocks should be avoided.
•Not
only does the preferred holder lack the legal claim of a bondholder (as a
creditor), but also he lacks the profit possibilities of the common stock
holder (as a partner).
•The only time to purchase preferred stock, if ever, is when
its price is unduly depressed during times of temporary adversity.
•
•Early
redemption of bonds
by issuers was commonplace before 1970, and resulted in an unfair advantage for
the issuer by not allowing the investor to participate in significant upside
values if interest rates fell.
•However, this practice
largely stopped.
•The investor should sacrifice a small amount of yield to ensure
that his bonds are not callable.
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