The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [14]
But of course we cannot be certain that bonds will work out better than stocks from today’s levels. The reader will immediately think of the inflation factor as a potent reason on the other side. In the next chapter we shall argue that our considerable experience with inflation in the United States during this century would not support the choice of stocks against bonds at present differentials in yield. But there is always the possibility—though we consider it remote—of an accelerating inflation, which in one way or another would have to make stock equities preferable to bonds payable in a fixed amount of dollars.* There is the alternative possibility—which we also consider highly unlikely—that American business will become so profitable, without stepped-up inflation, as to justify a large increase in common-stock values in the next few years. Finally, there is the more familiar possibility that we shall witness another great speculative rise in the stock market without a real justification in the underlying values. Any of these reasons, and perhaps others we haven’t thought of, might cause the investor to regret a 100% concentration on bonds even at their more favorable yield levels.
Hence, after this foreshortened discussion of the major considerations, we once again enunciate the same basic compromise policy for defensive investors—namely that at all times they have a significant part of their funds in bond-type holdings and a significant part also in equities. It is still true that they may choose between maintaining a simple 50–50 division between the two components or a ratio, dependent on their judgment, varying between a minimum of 25% and a maximum of 75% of either. We shall give our more detailed view of these alternative policies in a later chapter.
Since at present the overall return envisaged from common stocks is nearly the same as that from bonds, the presently expectable return (including growth of stock values) for the investor would change little regardless of how he divides his fund between the two components. As calculated above, the aggregate return from both parts should be about 7.8% before taxes or 5.5% on a tax-free (or estimated tax-paid) basis. A return of this order is appreciably higher than that realized by the typical conservative investor over most of the long-term past. It may not seem attractive in relation to the 14%, or so, return shown by common stocks during the 20 years of the predominantly bull market after 1949. But it should be remembered that between 1949 and 1969 the price of the DJIA had advanced more than fivefold while its earnings and dividends had about doubled. Hence the greater part of the impressive market record for that period was based on a change in investors’ and speculators’ attitudes rather than in underlying corporate values. To that extent it might well be called a “bootstrap operation.”
In discussing the common-stock portfolio of the defensive investor, we have spoken only of leading issues of the type included in the 30 components of the Dow Jones Industrial Average. We have done this for convenience, and not to imply that these 30 issues alone are suitable for purchase by him. Actually, there are many other companies of quality equal to or excelling the average of the Dow Jones list; these would include a host of public utilities (which have a separate Dow Jones average to represent them).* But the major point here is that the defensive investor’s overall results are not likely to be decisively