Before the 1920s, it was not a common experience for America’s affluent class to own any stocks at all in their portfolio, unless they had a hand in creating the company, working for it, or a close association with it (e.g. you’ve been living in St. Louis since the 1890s, and Anheuser-Busch is the largest profitable enterprise in the city, so you might own that).
In a way, corporate bonds were regarded in the same way that long-term investors think about purchasing stocks today; an act of total ownership. If you purchased a General Mills bond in 1905 that was secured by a mortgage on the flour mill, you felt pretty secure. If Americans stopped eating cereals and using flour, you’d get a big chunk of your investment back when the factory got auctioned off. Talking about a portfolio of common stocks would have made you persona non grata in affluent circles, as you would have been seen as the reckless lunatic that owned assets that were only tied to profitability and not tangible assets.
What changed in the 1920s?
There were two developments: one was intellectual, and one was cultural.
On the intellectual side, Edgar L. Smith wrote a book titled, “Common Stocks as Long-Term Investments” that pointed out two things. First of all, he noted that the returns experienced by American stockholders beat the returns of American bondholders by two to three percentage points per year. Fine, everyone knew that then.
But his greater insight had to do with safety: he pointed out that, despite the higher volatility in stock price, the thirty largest American companies offered a guarantee of sorts: over a typical investment period dating from two decades before the Civil War until 1923, you were guaranteed to break even within six years if you bought your stocks at the average price point those stocks experienced during the year. The other insight Smith noted was this: under a worst case scenario, in which you purchased each of the thirty largest American firms at the absolutely most expensive day that it was possible to do so, you broke even within 13.5 years. The typical experience, though, was that you would double your investment capital every five to six years.
That might be an influential argument in the faculty lounges of Harvard, Yale, and Princeton at the time, but it wouldn’t be enough to actually transform behavior. If you were the kind of person deliberating between corporate bonds and common stocks back in the 1920s, you are also going to be the kind of person that thinks in terms of worst case scenarios. If you’re culturally used to buying corporate bonds, knowing that stocks could take 13.5 years for you to break even isn’t exactly something that is going to cause you to have a Paul-going-to-Damascus type of conversion if all your life you had been trained that corporate bonds are equated with wealth preservation.
What really changed was this: Social proof, and the rise in common stock prices once it became clear that the United States and its economic engine were going to emerge victorious in WWI. All of a sudden, the guy at the country club was buying a bigger house, a model T Ford off the line, and this newfangled household appliance gadget called a toaster. While I think envy and jealousy is responsible for a lot of global misery because people make financial decisions aimed at impressing those that travel in their social circles (without pausing to reflect upon what it must say about the other person’s quality if they respond to you better with a $400,000 house than a $250,000 house), I don’t discount Seth Godin’s wisdom that change happens when people see something new and answer the question “Do people like me do stuff like this?” in the affirmative.
I mention all of this as a matter of perspective. A century ago, buying General Mills, Procter & Gamble, and General Electric common stock was seen as being a bold investor. Nowadays, we associate those stocks with, “Oh, that’s something Aunt Mildred is interested in.” And instead, the airwaves get populated by companies trading at 100x earnings, 75x profits, or whatever—that won’t be around 20 years from now. That’s not investing; that’s trying to buy a lottery ticket based on a narrow window in time and hope and pray the price of the stock goes up. That’s not much of a difference between that and going to a casino.
The right answer lies in the middle ground; people that would only own corporate bonds were probably too conservative in preserving wealth (although, if 7-8% cash returns from your bonds fully funds your lifestyle, why fix something that isn’t broken?), and nowadays, we ignore the perfectly good common stocks because they are too boring. Hopefully you recognize the intelligent middle ground.