The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [48]
Moving Beyond Uncle Sam
Mortgage securities. Pooled together from thousands of mortgages around the United States, these bonds are issued by agencies like the Federal National Mortgage Association (“Fannie Mae”) or the Government National Mortgage Association (“Ginnie Mae”). However, they are not backed by the U.S. Treasury, so they sell at higher yields to reflect their greater risk. Mortgage bonds generally underperform when interest rates fall and bomb when rates rise. (Over the long run, those swings tend to even out and the higher average yields pay off.) Good mortgage-bond funds are available from Vanguard, Fidelity, and Pimco. But if a broker ever tries to sell you an individual mortgage bond or “CMO,” tell him you are late for an appointment with your proctologist.
Annuities. These insurance-like investments enable you to defer current taxes and capture a stream of income after you retire. Fixed annuities offer a set rate of return; variable ones provide a fluctuating return. But what the defensive investor really needs to defend against here are the hard-selling insurance agents, stockbrokers, and financial planners who peddle annuities at rapaciously high costs. In most cases, the high expenses of owning an annuity—including “surrender charges” that gnaw away at your early withdrawals—will overwhelm its advantages. The few good annuities are bought, not sold; if an annuity produces fat commissions for the seller, chances are it will produce meager results for the buyer. Consider only those you can buy directly from providers with rock-bottom costs like Ameritas, TIAA-CREF, and Vanguard.11
Preferred stock. Preferred shares are a worst-of-both-worlds investment. They are less secure than bonds, since they have only a secondary claim on a company’s assets if it goes bankrupt. And they offer less profit potential than common stocks do, since companies typically “call” (or forcibly buy back) their preferred shares when interest rates drop or their credit rating improves. Unlike the interest payments on most of its bonds, an issuing company cannot deduct preferred dividend payments from its corporate tax bill. Ask yourself: If this company is healthy enough to deserve my investment, why is it paying a fat dividend on its preferred stock instead of issuing bonds and getting a tax break? The likely answer is that the company is not healthy, the market for its bonds is glutted, and you should approach its preferred shares as you would approach an unrefrigerated dead fish.
Common stock. A visit to the stock screener at http://screen. yahoo.com/stocks.html in early 2003 showed that 115 of the stocks in the Standard & Poor’s 500 index had dividend yields of 3.0% or greater. No intelligent investor, no matter how starved for yield, would ever buy a stock for its dividend income alone; the company and its businesses must be solid, and its stock price must be reasonable. But, thanks to the bear market that began in 2000, some leading stocks are now outyielding Treasury bonds. So even the most defensive investor should realize that selectively adding stocks to an all-bond or mostly-bond portfolio can increase its income yield—and raise its potential return.12
Chapter 5
The Defensive Investor and Common Stocks
Investment Merits of Common Stocks
In our first edition (1949) we found it necessary at this point to insert a long exposition of the case for including a substantial common-stock component in all investment portfolios.* Common stocks were generally viewed as highly speculative and therefore unsafe; they had declined fairly substantially from the high levels of 1946, but instead of attracting investors