Graham cites a survey conducted by the University of Michigan for the Fed. The first survey was published in the Federal Reserve Bulletin in July 1948. People were asked, "Suppose a person decides that he does not want to spend his money. He can put the money in a bank or in bonds. Or he can invest the money somewhere else. What do you think would be the right thing to do with money today? Put it in a bank, buy savings bonds, invest in real estate, or buy common stock." Only 4 percent of people said that common stock would give a satisfactory return. About 26 percent of people considered it 'unsafe' or 'unfair'. From 1949 to 1958, the stock market earned the highest return in the 10-year history.
During this period, the stock market earned an average annual return of 187 percent. BusinessWeek conducted a survey in late 2002, whose findings echo those of the initial Fed survey. The survey found that only 24 percent of investors were willing to invest in mutual funds or stock portfolios. Three years earlier, the figure was 47 percent.
Speculation has advantages over all others. First, without speculation, new and untested companies (such as Amazon.com, or formerly Edison Electric Light Company) would never be able to raise the capital needed to expand. The lure of the prospect of a large profit is the lure that sublimates the machinery of the startup. Second, risk is exchanged (but never eliminated) every time a stock is bought or sold. The primary risk a buyer faces is the risk that the price of the stock will fall. The seller is also left with a waste risk, the risk that the price of the stock he has sold may go up.A margin account allows you to buy stocks using money borrowed from a brokerage. Investing with borrowed money can help you earn more money when the stock price rises. However, your entire profit can be wiped out if the stock price falls. The collateral for a loan is the value of the investment in your account. This means that if this value falls short of the amount borrowed, you must put up more money. For more information on margin accounts, see www.sec.gov/investor/pubs/margin.htm, www sia.com/publications/pdf/MarginaA.pdf, and www.nyse.com/pdfs/2001factbook pdf.
Reread Graham's quote. Notice what one of the greatest investing experts of all time is saying. Future security prices cannot be predicted. And as you read the passage, notice how what Graham tells you is meant to help you cope with the reality that, because you can't predict the market's behavior, you must learn to predict and control your own behavior.How accurate was Graham's forecast? At first glance, it seems that his forecast was pretty much correct. From the beginning of 1972 to the end of 1981, stocks generated an average annual return of 65 percent. (Graham did not specify a time period for his forecast, but it can be assumed that he was looking at a 10-year time period.) However, inflation increased at a rate of 8.6 percent per year during this period. As a result, all the benefit of the stock's growth was lost to inflation. In this section of his chapter, Adam explains the essence of the 'Gordon equation'. According to this equation, the future return of the stock market is the sum of the current dividend yield and expected earnings growth. With dividends of less than 2 percent in early 2003, long-term earnings growth of about 2 percent, and inflation of more than 2 percent, a long-term annual return of about 6 percent is possible in the future. (See note on Chapter 3)After 1997, Treasury Inflation Protected Securities (TIPS) were introduced. Since then, investors who expect rising inflation have viewed stocks as a disadvantage. Unlike other bonds, TIPS rise in value when the Consumer Price Index (CPI) rises. Thus, these securities protect investors against the loss of value of money due to inflation. Stocks offer no such guarantee. In fact, stocks offer relatively little protection against high rates of inflation. (For more, see the notes on Chapter 2.)Today, existing alternatives to the Dow Jones Industrial Average include the Standard & Poor's 500-stock index (S&P) and the Wilshaw 5000 index. The S&P focuses on 500 large and well-known companies that represent approximately 2 percent of the total value of the U.S. equity market...The Wilshaw 5000 tracks nearly every significant publicly traded stock in the United States. There are roughly 6,700 of these stocks, but because the largest companies represent the majority of the index's total value, the Wilshaw 5000's returns generally are similar to those of the S&P 500. Several low-margin mutual funds allow investors to hold the stocks in these indexes in a single, convenient portfolio. (See Chapter 1)*For more details, see Chapter 6.See Chapter 1 for more advice on well-established investment funds.'Professional administration' by 'an accredited investment-advisory firm' is discussed in Chapter 10. 'Dollar cost averaging' is explained in Chapter 5.
Short selling (or shorting) a stock involves betting that the price of a stock will go down rather than up. Shorting is a three-step process: first, you borrow shares from someone who owns those shares; then you immediately sell the borrowed shares; and finally, you replace them with shares that you later buy. If the stock price falls, you will be able to buy your replacement shares at a lower price. The difference between the selling price of the borrowed shares and the buying price of the replacement shares is your gross profit (less any dividends, interest charges, or brokerage costs). However, if the stock price goes up rather than down, your potential loss may be unlimited - meaning that short selling is too much of a speculation for most investors.In the late 1980s, as hostile corporate takeovers and leveraged buyouts multiplied, Wall Street set up institutional arbitrage desks to......profits could be made from errors in the pricing of these complex deals, but these desks became so efficient at what they did that it was now impossible to make easy profits. Eventually many of these desks were closed, but this type of trading is no longer possible or suitable for most people. In fact the size of the deals must be very large to generate meaningful profits and only deals worth multimillion dollars are able to do so. Wealthy individuals and institutions can use this strategy through hedge funds. These hedge funds specialise in merger or 'event' arbitrage.The Rothschild family was a major force in European investment banking and brokerage in the nineteenth century. The leader of the Rothschild family was Nathan Mayer Rothschild. For a fascinating history of the family, see "The House of Rothschild Money's Prophets," 1798-1848 by Niall Ferguson (Viking, 1998).
http://www.sec.gov/investor/pubs/margin.htm
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