Borrow or Sell?

For many people, being short of cash is chronic. Naturally, in such situations you need to borrow money. But which way? We assume here that an investor is usually able to keep his expenses within bounds. And yet, we also recognise that no matter how carefully he plans, sometimes he finds himself needing to spend consider­ably more money than his current income provides. Only a reckless person assumes he will never have to face this situa­tion.

A man lacking financial assets has only one way to raise extra cash: he must borrow money, probably paying a high interest or service charge. But a man with savings has more choice, for he can sell or redeem some of his investments. However, if he owns nothing that he can surrender without considera­ble sacrifice, then borrowing may be the best way for him to raise cash. By putting up an investment as collateral at a commercial bank, he can borrow at less expense than the man without savings.

Suppose a man has put all of his savings into a life-insurance policy with a cash surrender value. If he surrenders that policy, then when he is ready to replace it he will have to pay the company's heavy sales load all over again, and maybe he will be penalized further in his physical examina­tion. So it is better for him to borrow money on his old policy. Or suppose he owns nothing but common stock, and when he wants cash, the price level is so low he hates to sell; instead, he uses his stock as collateral for a bank loan. But with a well-balanced investment program, he would avoid get­ting into this fix by the simple expedient of having part of his capital in a fixed-dollar investment, cashable without loss.

Borrowing can enable a saver to make a worthwhile invest­ment that is otherwise impossible. Especially in buying a home, he may be obliged to borrow money, because a house must be bought as a unit. The cost of a complete house is so large that even if a man can swing the deal, it is probably unwise to put so much of his capital into one investment at one time. The advantages of a mortgage over other types of loan are dis­cussed in a previous chapter headed "Home-owning and Debt."

Another reason for borrowing is to make a larger purchase possible. Suppose a man wants to buy some corporate stock that he thinks will rise rapidly in price. By borrowing, he can buy more of that stock, and a bank's interest charge will be less than his expected increase in stock value. This is a fine scheme, provided everything works out as planned. But sup­pose the value of the stock goes down instead of up. The borrower may be forced not only to sell all of his stock, but also to find cash elsewhere to pay off the balance of the bank loan. The larger the loan compared to total stock value, the greater the risk.

During the great stock-market boom back in 1928 and 1929, a speculator could buy stock by paying cash for only one tenth of the cost, borrowing the other nine tenths from the broker. When stock prices dropped only moderately, he owed the broker more than his stock could be sold for, and he was forced to sell out. Each of these distress sales tended to pull down market prices and, in turn, to force other borrow­ers to sell. This lasted from late 1929 until early 1933. Dur­ing the collapse, an investor who owned stock free of debt, and hung onto it, did not necessarily lose anything, because in a few years stock values and dividends rose again to rea­sonable levels.

Thus to borrow money can be profitable, but it increases the gamble in investing. (A moderate-sized mortgage may be an exception.) If you want no unnecessary risk, plan your invest­ing so that you always have something you are able and willing to sell or redeem, if you need cash. Then if you run into such serious difficulty that this plan fails to furnish enough cash, you can turn to borrowing as a last resort.

When a family buys clothing or a refrigerator, ordinarily they expect to use the item until it is worn out or obsolete. They have no reason for inquiring whether the item is easy to resell. But when a man buys an investment, even though he expects to keep it for the rest of his life, he has no way of knowing whether or when he may want to sell it. Some day he or his heir may be short of cash and will have to sell some principal. Or sometime he will want to switch to a new investment that looks better than the old one. So before buy­ing, he needs to have the answer to this question: "Can I resell it easily, quickly, at any time?" In other words,' is it liquid, always readily marketable? If on some of his invest­ments the answer is "No," that is all the more reason for his having others that can answer, "Yes."

Bonds and Savings Institutions

Probably the most perfectly cashable of all investments in this country is a savings bond of the U. S. Government, espe­cially an E bond. No matter how bad conditions may be, the Government does not reserve the right to delay payment. An owner merely has to identify himself at a bank or other bond agency, and in a few moments he has the cash, in the amount printed on the bond. Of course, if the banks should close, it might be impossible to raise cash on any investment for a short while. This condition is discussed a little further on. Aside from that possibility, an E bond is practically as liquid as currency in your pocket, and with interest added.

Among bonds, only the U.S. savings bonds are strictly fixed-dollar, meaning that an owner can surrender them at any time at a price known in advance. On other bonds, including U. S. Treasury bonds, the issuing government or corporation has no responsibility for redeeming, until the maturity date arrives. A bond-issuing organization may have a high cred­it standing, but one of its bonds may still be quite difficult to sell, because no one happens to want to buy that specific bond. When an investor is about to buy a bond, naturally the salesman does not warn him of the difficulty of re­selling; so an amateur buyer learns only by personal experi­ence, as the writer himself did. Probably the simplest way to judge whether a bond is readily saleable is to see if its price appears frequently in one of the metropolitan newspapers that print prices daily on hundreds of bonds.

Contact between bond seller and buyer is usually made through a stock dealer or broker. The price is whatever the seller and buyer can agree on. A seller may run into a serious drop in price, especially in a year such as 1957, when a tight money market has pulled down the prices on old bonds. But when an investor must raise money, he is much better off if he owns a bond he can sell at a sacrifice rather than one that nobody wants to buy at any price at that time.

A deposit in a bank or savings institution can usually be cashed with no difficulty - so this is a good alternative when you intend to insure yourself against having to borrow money. Since 1942 so few of these institu­tions have failed that most people assume their deposits are perfectly liquid. But during the 1930's 11,000 of these in­stitutions in the United States were closed, temporarily or permanently, on account of financial difficulties. The establish­ment of insurance systems and other improvements has made it quite unlikely that trouble will reoccur on such a big scale as in the 1930's. But a saver today has no grounds for as­suming that merely because a place is called a bank or savings-and-loan or credit union or such, it will always pay off on demand. Nor should he assume he knows what an institu­tion means when it says it is "insured" or "safe."

Nineteen out of twenty banks in this country are covered by the Federal Deposit Insurance Corporation, but this leaves over 1,000 banks not so covered. Many savings and loan as­sociations give the impression that savings placed in them are just as safe as in an insured bank. They display seals that say: "Safety of your savings insured up to $10,000. Feder­al Savings and Loan Insurance Corporation."

Now suppose a community contains two savings institu­tions, one a savings and loan association insured in F. S. & L. A., the other a savings bank or the savings department of a commercial bank insured in F.D.I.C. Some day business in the community gets so bad that a good many savers want to withdraw their deposits, and neither institution has cash enough to meet these demands promptly. Then what hap­pens?

When a bank cannot pay its depositors within the time lim­it stated in its rules, then legally it has failed. The F.D.I.C. steps in immediately and pays depositors promptly. Here the word "insured" means exactly what a layman would suppose it means. But in the savings and loan association, nothing happens, for the association is not legally obliged to pay its members promptly. It can pay off gradually, taking many years to do so. The insurance in the F.S.&.L.A. does not go into operation unless the association's finances are in such bad shape that it will never be able to pay off its members. And even then, a depositor may find that instead of his receiving cash, his deposit has been transferred to another association. So in a savings and loan association, "insured" means that eventually a member will get his money back, if he lives long enough.

A reader may think, "Yes, but the savings and loan asso­ciation pays a higher rate of dividend, and probably condi­tions will never again get so bad that members cannot withdraw their money promptly." That argument has weight, provided a saver is limiting himself to fixed-dollar invest­ments. But why accept the low rate of income and absence of growth in dollar value that is common to all savings in­stitutions and savings bonds, except in return for an absolute guarantee that whenever needed, principal can be cashed promptly, without much loss of principal or interest? If a saver is willing to take the risk inherent in a savings and loan association, then why not put that money into other investments with better average returns?

Selling Stock

On corporate stock or any equity with a variable market value, salability has two angles, the first one being: "Can I sell it readily, when I need to?" Some stock may be difficult to sell at any price. This situation is the same as on some bonds discussed earlier in this chapter.

Choosing a stock that will sell readily means making sure that the stock has a regular market. An easy way of check­ing this is to see if its price is printed frequently in some publication. The New York Times prints prices daily on more than 2,000 stocks, mostly those listed on exchanges. Wall Street periodicals give prices on still more stocks. The National Association of Securities Dealers issues to its members a daily report, quoting prices on many stocks sold over the counter, not listed on an exchange.

Extremely bad business conditions have sometimes halted the sale of all stock. The last time this happened was in 1933, when the closing of the banks made it practically im­possible, for a few days, to make ordinary commercial pay­ments. The entry of the United States into World War II, in 1941, caused stock prices to drop pretty low, but the market kept open. Ignoring the question of price, many issues of corporate stock are just about as marketable as a savings bond.

Having settled that a stock is marketable, an investor must still face the second question: "Will I be willing to sell stock when I need cash?" When the current price of stock is high, the principal objection to selling may be the income tax on the capital gain. While paying a tax is always unpleasant, it is hardly a good reason for refusing to sell at a good price, if the owner needs cash, unless he is in a high tax bracket. But when the current price of stock is low, selling can mean a big sacrifice.

An investor cannot forecast what the stock-market level will be at the future time when he happens to need extra cash. But his need is more likely to arise when stock prices are low. The same decline in business prosperity that causes the stock market to drop can also cut his salary or cause him to lose his job. So the ability to sell common stock can be a weak reed to lean on for the raising of extra cash and the problem of how to borrow money remains..

In a mutual fund, the open-end type of investment com­pany, a stockholder is protected against ever having to accept a bargain price. Part of the meaning of "open end" is that a mutual fund stands ready to redeem the shares it issues, and the redemption value is figured automatically on the combined value of all the stocks and other assets the fund owns. So if the share value in a broadly diversified mutual fund is disappointingly low, it is because general stock-market values at that time are down. Also, a mutual-fund portfolio, because it is diversified, does not drop in value as much as do some of the individual stocks included in its holdings.

A "balanced" mutual fund has part of its assets invested in bonds or preferred stocks or both, the remainder in com­mon stocks. This causes the value of a share issued by the fund to fluctuate less than in a fund whose portfolio holds only common stocks. When general stock-market values drop, the share value in a balanced fund does not drop as far as in a common-stock fund. But on this point, a fixed-dollar investment with genuine insurance is better than a fund con­taining any stock at all.

This chapter can be condensed into one brief sentence: Before buying an investment, find out about cashing it so that you can insure against having to borrow money..