A famous Wall Street story concerns a young man who was in the early stages of learning investing formula. He had a problem, so he went for advice to an elderly sage noted for his shrewd investment judgment. The fact was, the young man said, that he had taken on quite an extensive line of stocks, but the market looked high—maybe too high—he thought possibly his position carried with it too many risks, and wondered if he shouldn't perhaps sell. He was so worried about this, he said, that he couldn't sleep nights.

The old man's counsel was simple and direct: "Sell," he said. "Sell back to the sleeping point."

Although there is no doubt that this advice smacks of imprecision, there is a good bit of wisdom in it. We may fairly assume that neither the young man nor his adviser knew for sure which way the market was going, but both were aware that the market was sufficiently shaky to cause legitimate worry. Translated into somewhat more orthodox investment terms, the advice meant: "Sell enough of your stocks so that a market collapse won't destroy you, but keep enough so that if your fears turn out to be groundless, and the market rises, you'll still profit to some extent; in the meantime, get some sleep."

At first glance, it may seem cynical on the old man's part not to outline for his protégé an exact and detailed course of action. But he could not honestly guarantee that he knew exactly what action might turn out to be best. Furthermore, the young man didn't want someone to tell him precisely what to do. All he wanted was some help in easing the pressure at a critical point, and the help he got seems eminently sensible.

Finding The "Sleeping Point"

n a real sense, the investing formula described in this book are designed to help you in the same way that the old man's advice helped his young friend—they inject an element of caution in your investing when caution seems advisable, they reduce the provision for caution when risks seem relatively low, and permit you to benefit from rising prices for common stocks. Moreover, once you incorporate a formula into your investment program, it works more or less automatically, thus allowing you to sleep nights in the knowledge that you are continuously hedging against various possibilities.

But just as the investment sage left it up to the young man to decide exactly what the "sleeping point" might be in his particular case, you can select a formula appropriate to your own temperament, financial circumstances and proclivity to insomnia. As will be made clear in later pages of this book, any of the formulas can be adjusted to suit the needs and preferences of any investor.

Although investing formula are designed to give unhedged and unambiguous indications for action, the investor should not feel that he is therefore giving up all personal control over his investments when he adopts a formula, since he selects it himself to fit his own requirements. A formula does not try to tell you what to do—it merely helps you do what you are already doing more profitably. For example, formulas cannot tell you which stocks to buy. This book assumes that anyone interested in formulas is already a relatively sophisticated investor and knows what kind of stocks he wants to buy, how to select them and where to go for advice in his particular areas of interest. But— by supplementing his knowledge of which securities with considerations of the equally important questions of when to own them and in what quantity—formulas can supply a valuable added dimension to his investment results and help put the management of his portfolio on a more professional level.

Along this same line, it is worth mentioning that although the true purpose of a formula is to supply the investor with an investment policy which is definite in its instructions at all times, you need not feel that you must follow the formula precisely in order to profit from it. You cannot, of course, ignore it altogether if you expect to benefit from it, but you can profitably use it as a touchstone or a general guide without swearing eternal allegiance to its dictates. You might, for example, want to use a formula, but also desire to increase or decrease your risks at various times for some reason. Your use of the formula will show you how far you are departing from your original plan, and will give you a well-ordered program to come back to when you are ready.

What A Formula Does

What, exactly, does an investing formula do? This question will be answered in considerable detail in later sections of this book, but a summary of a formula's usefulness would include two main functions it fulfills.

First, over a full stock market cycle, it will improve your investment profits without the application of any thought whatever on your part. As is well known, there are many investors who do not believe that the market will ever go through a full cycle again—that the direction of the market is in a permanently upward movement, except for temporary, minor dips. It might be worthwhile to point out—without seeming to be pessimistic —that there are some good arguments against an indefinite continuation of bull markets.

In the 12-year period from June, 1949, to June, 1961, the market—as measured by the Dow-Jones Industrial Average— rose over 300 percent, a compound rate of gain of about 13 percent annually. Assuming that there is some connection between the nation's economy and the stock market, this rate of gain in the market cannot be maintained indefinitely, because the economy ordinarily grows at a rate of three percent or so (this varies, but it never reaches 13 percent). Even granted that the market was too low in 1949 (which it most certainly was), that does not mean that a steady 13 percent rate of gain will not have put it too high at some point. If this perhaps gloomy suggestion turns out to be wrong, and the market does continue forever upward, then formulas will be useless, since they do assume that the stock market is quite cyclical.

The second purpose of an investing formula—apart from the question of profiting from complete market cycles—is to provide a means of profiting from more minor fluctuations. It is undeniable that the market will continue to fluctuate, and a formula allows the investor to benefit from these fluctuations by specifying conservative investment policies when the market is relatively high, and more aggressive policies when it is relatively low.

Since formulas ordinarily appear rather complicated, can the small investor profitably use them? The answer is definitely yes. Some formulas are complicated, it is true, and the reader will find in later pages some that are so complex as to be unsuitable for most investors. But most formulas do not fall into this category. The most widely used formulas today, in fact, are based on extremely simple principles and can be used by anyone with a rough knowledge of grade-school arithmetic. Special measures to adapt formulas to the needs of small investors will be discussed to some extent later on, but it is worth noting that small investors are just as likely to want to improve their profit performance in the market as are larger investors. And there is no particular disadvantage in having a small portfolio when you use a formula.

Security vs. Uncertainty

All investors—large, small and medium-size—are in the same basic quandary. They would like to be sure of what is going to happen to their capital, and so are inclined to appreciate the features of fixed-income investments such as savings accounts, bonds and commercial paper.

In such investments, their capital is guaranteed, and (except in the case of savings accounts) so is their interest. On the other hand, there are few opportunities for appreciable profits in these areas, and no protection against a decline in the value of the dollar. Consequently, they are attracted by the characteristics of common stocks, where neither their capital nor their return is guaranteed, but which offer substantial opportunities for profits through capital gain.

How to resolve the dilemma? It is obvious that the great difficulty with the stock market is its uncertainty. One workable suggestion of reducing the damage this uncertainty can do has been often made: don't buy common stocks at all. Most investors tend to regard this idea as, although practical, rather extreme, and are reluctant to abandon the possibilities of profit that exist in common stocks. The investing formula idea is simply a form of protection against uncertainty. Formulas are designed to allow the investor to profit from the advantages of owning common stocks, while providing him with a measure of protection against their handicaps; to give him some of the stability offered by fixed income investments, while not condemning him to a low return on his money. The whole point of formulas is to make the best of both these worlds.