Stock Forecasting?
If forecasting in the stock market is dangerous, how can an investor time his buying and selling of stock? The simplest answer is to ignore the price level, to buy stock whenever he has savings to invest, and not to sell unless he must. And he must also own fixed-dollar deposits because it opens an opportunity to buy stock at lower-than-average prices and to sell at higher than average, without forecasting.
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The Investment Ratio.
Momentarily ignoring the question of timing of stock purchases, let us suppose A has $1,000 of new savings to invest on the first day of each month. With half of this he buys common stock, and the other half he puts it into a savings deposit. His savings are always divided equally between stock and cash reserve. During the first year he deposits $6,000 in the savings bank and pays $6,000 for stock, buying 120 shares, an average of 10 shares a month, at an average price of $50 a share. (For simple illustration the expense of buying and selling stock, also the income on investments, are excluded here.)
Now let us look at A’s market or redemption values. On January 1st of the second year the current value of his savings deposit, disregarding interest, is the same as his cost. But the market value per share of his stock has dropped to $40, giving his 120 shares a value of $4,800, or $1,200 less than his savings deposit. With this drop in price, his usual $500 monthly purchase would pay for 12 shares, as compared to his previous average of 10 shares a month.
At this point A decides he wants the market value of his stock to equal his savings deposit, and that he should adjust his buying to accomplish this. So on January first he makes no savings deposit but puts all of his $1,000 monthly saving into stock, thus raising the total stock value to $5,800, as compared to $6,000 in the savings deposit. With the $1,000 he buys 25 shares, 2.5 times as many as his former monthly average. Later on, when a rise in price causes his stock value to exceed his savings deposit, he offsets this by putting all or most of his new savings into the savings deposit.
Action Plan.
Now let us expand A’s action into a plan. First, an investor selects a standard ratio that he will maintain between the market value of his common stock and his cash deposit. The idea can be applied to any ratio an investor prefers.
To maintain a stable lifestyle for the family, some additional reserve says $5,000 would be needed for personal emergencies outside the investing portfolio. On starting to save $1,000 a month, he might adopt a standard ratio of $800 stock to $200 fixed-dollar deposit, but not counting $5,000 in his emergency reserve. For the first 5 months all his savings go into this special reserve, thus completing his goal for emergencies. In the sixth month, observing his standard ratio, he puts $200 into cash deposit and $800 into stock.
Having chosen a standard ratio, he must not allow current stock-market conditions to persuade him to change the ratio. If he adopts one ratio when stock prices are dropping, and changes to another ratio when prices are rising, he is slipping into forecasting. A standard ratio has no chance of success unless, after an investor adopts it, he parks his emotions outside.
Buying under a standard ratio goes this way: When an investor has new savings available, before placing them he finds out what the current values are of his total stock and his total bank deposit, not counting the emergencies reserve. Then he puts his new savings into whichever one is low in value compared to his standard ratio, as A did with his $1,000 monthly savings.
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No New Saving Situation.
When an investor has little or no new savings, he can gain the benefit of the standard-ratio plan by applying the same ratio to both selling and buying stock. Suppose B’s annual spending is exactly equal to his income, so that he has no new savings, nor is he spending any capital. His standard ratio is 1 to 1, and the current value of his capital agrees with this; 2,000 shares of stock at $10 a share total $20,000, and $20,000 in a savings deposit.
Then the value of a share drops to $8, making his total stock value $16,000. To restore his values to agreement with his standard ratio, he withdraws $2,000 from savings deposit and buys 250 shares of stock. This cuts his reserve to $18,000, and also raises his current stock value to $18,000.
Next, the value per share rises to $10, the same as the original figure, and his 2,250 shares have a current value of $22,500. Again acting to restore his values to his standard ratio, he sells 225 shares of stock for $2,250, and adds this to his savings deposit. This leaves him with 2,025 shares of stock, valued at $20,250, and $20,250 in bank deposit, his total capital being $500 larger than at the start. (For accuracy, the expense of buying and selling should be subtracted from this gain.)
Stock Value Movement and Value Gap.
A switch of old capital between stock and bank deposit should not take place until stock value has moved far enough away from the standard ratio to justify the expense and trouble of changing. In the above example, B bought stock when his stock value was 20 per cent below his reserve value. And he did not sell stock until his stock value was 25 per cent above his bank deposit value. The desired gap can be provided automatically by setting up a standard ratio for selling stock that is different from the buying ratio.
Ratio System Requires Discipline.
It helps you decide when the share price moves down, how many shares to buy into your stock, drawing from your available bank deposit. It also prompts you during the stock soaring months, how many shares to sell in order to keep to your initially set ratio.
This Standard Ratio Investing System has to be followed with discipline in order to achieve winning goals. The buy low and sell high obviously comes into fruition here as you see your combined stock and bank deposit value grows over time.
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