Borrowing to Increase Savings
A MAN of prominence recently advised his son, who was about to venture forth into the world to earn his own living, ‘Young man, keep out of debt.’ No sooner had the lad found a position with a large industrial corporation than there filtered down to him from the president of the company the startling advice, ‘Young man, get into debt.'
Naturally, the young man was puzzled. Anyone would be puzzled at first by such conflicting counsel. It is reasonable to suppose, however, that when the parent advised his son to keep out of debt he was merely counseling him to live within his means. On the other hand, the corporation president knew from his own experience that one could not go far in business without borrowing; he must also have known that employees who had borrowed money in order to buy the stock of his company had thereby increased their earnings, savings, and efficiency.
In general, money is borrowed for one of two purposes — either to tide over an emergency or to increase profits. Most commercial borrowing is for the latter purpose. For example, a business finds that it can make a 10per-eent return on its invested capital at a time when money can be borrowed at 6 per cent. The obvious thing to do in the circumstances is to borrow the money, expand the business, and ’scalp’ a profit of 4 per cent. There are times when every business that wishes to expand or is alert for opportunity must borrow a portion of its capital.
If going into debt is one of the secrets of business success, should it not also have an important place in the investor’s programme? The case could be argued at length, pro and con. It could be shown that going into debt has its dangers, not only for certain classes of security buyers, but for imprudent business men as well. As a general rule, however, the investor who has learned to save regularly and to invest carefully can be trusted, no less than the conservative business man, to borrow with prudence.
One of the simplest ways for the small investor to increase his income with the aid of borrowed money is to buy securities on the installment plan. There are now hundreds of thousands of railroad, public utility, and industrial employees in this country who have acquired stock in their respective companies by this means. Under the ordinary installment-purchase plan, the employee does not actually borrow the money required to ‘carry ’ his stock, — the company or some other agency does that for him, — but he does commit himself definitely to the moral obligation to save money until his stock is finally paid for. By means of regular weekly savings, he at length accumulates a considerable sum of money which might otherwise have been frittered away in foolish extravagances.
The small investor who is not eligible to participate in these employee-stock-purchase plans can turn to the bond houses, any number of which nowadays provide installment-purchase plans for small customers; or he can make weekly payments to a building and loan association and let these payments accumulate at interest until he has a fund sufficiently large to permit the purchase of securities outright.
When it comes to actual borrowing for the purpose of buying securities, one should reëxamine the loan clauses of one’s life-insurance policies. Practically all standard policies permit the insured to borrow from the insurance company, up to about the cash-surrender value of the policy, at an interest rate of 6 per cent. This is a pretty high rale of interest to pay if one is trying to scalp a profit on conservative investments. It should be noted, however, that policies issued prior to the war contain loan clauses pros iding for an interest charge of only 5 percent. If, therefore, one is fortunate enough to have one or more pre-war policies, it is perfectly sound finance to borrow on these policies and use the proceeds to buy investment securities yielding more than 5 per cent. The pleasing feature about borrowing on a life-insurance policy is that the loan does not mature, and the rate of interest cannot be raised.
Borrowing at a bank is somewhat more complicated for the reason that a commercial bank is not prepared to make the kind of loans that would enable the investor to carry securities. The investor needs a loan maturing several months hence, whereas a bank must see to it that the bulk of its loans are of short maturity—thirty, sixty, or ninety days. Here there is a definite conflict of interest. In practice, however, these conflicting interests can be adjusted in part. Where one has maintained a good deposit account at one’s bank and can offer readily marketable securities as collateral, the banker is usually willing to grant a loan for three months, it being understood, though not in writing, that the loan can be renewed at maturity for a smaller amount.
Finally, securities may be bought and carried with the aid of a broker. An investor wishing to buy, say, $4000 worth of investment securities in advance of his ability to pay for them may turn over to the broker highly marketable bonds to the value of $1000, together with an order to buy.
The broker will then borrow the money, buy the securities, and deposit them with the lender as collateral for the loan, charging the investor for the interest he pays plus an additional charge of 1 per cent per annum for his own services. These combined charges may not be in excess of what the investor would pay a banker if he borrowed on his own account, because the broker is in a much stronger bargaining position with money lenders than the individual investor is. One of the great advantages of using the broker is that he relieves the investor of the worry and bother of renewing a loan every three months.
During the year 1924 there were many conservative investors who, realizing that security prices were out of line with interest rates ‘for the long pull,’ used the broker extensively as a means of filling their investment requirements several years in advance. To-day, these investors are very fortunately situated. They have been able gradually to reduce their loans with the broker out of current savings and, from time to time, to come into actual possession of a bond or stock certificate worth far more than the 1924 cost. Moreover, the profits they have been able to scalp during the past four years have served the useful purpose of further reducing their accounts with the broker.
Scalping a profit on borrowed funds is not a safe pastime for the amateur. It is all right for the amateur to buy on the installment plan or to impose upon himself any other incentive plan for saving. But it requires foresight and sound investment judgment born of experience to scalp profits with safety. Success lies in knowing when to get out of debt quite as much as in knowing when to borrow and what to buy. In times of high security prices and rising interest rates the safe policy is to reduce bank and broker loans rapidly and to discontinue scalping operations altogether.
GEORGE E. PUTNAM