The “Yale Plan”
by Chetan Parikh
  
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In a must-read book, “Templeton’s Way with Money”, the authors, Jonathan Davis and Alasdair Nairn, reproduce a memo that Sir John Templeton wrote to his clients in 1945. It contains timeless investment wisdom.

 

“It is a continual source of surprise to Mr. Vance, Mr. Dobbrow and me, when speaking for the first time with investors with whom we have not spoken before, that so very many people seem never to have thought out comprehensively the nature and problems of investment management. So many go along, year after year, in a haphazard manner, buying a stock now and then whenever some situation, which particularly strikes their fancy, is called to their attention.

 

In a steady or rising market, the haphazard investor usually obtains profitable results and is lulled into a false sense of security. Then along comes a decline like those which culminated in 1921, 1932, 1938, and 1942 and the good record is more than wiped out, because he had no plan for capturing and locking up the profits in the happy days.

 

In a rising market, inexperienced investors may obtain the best results, results far surpassing the averages, because they often select highly volatile stocks. As every analyst knows, the fastest rises are to be expected in low priced stocks, stocks of marginal companies, and stocks of companies having large debt and preferred claims. It only takes a few minutes to select a list of stocks which is sure to surpass the market averages, if the average rises. The catch is that, if the market declines, those same stocks are the ones which fall with disastrous acceleration.

 

Many people act as if the selection of particular stocks and bonds is about all there is to the problem of conducting an investment program. Of course, the element of “selection” is important. A carefully thought out method for weeding out overvalued stocks and replacing them with undervalued stocks does produce profits. But the backbone of an investment program is the question of “when to buy” and “when to sell.” The first step in planning is to divide the stocks and equities on the one hand from the cash and bonds on the other. The second step is to think out and adhere to a program for shifting out of stocks when they are high and back into stocks when they are again quoted at bargain prices.

 

The stock market always has been, and always will be, subject to wide degrees of fluctuations. When prices decline farther and farther, it is only natural human emotion to become cautious. Investors who have no prearranged plan to guide them not only fail to add to their stock holdings at the lower levels (sometimes because they have nothing left to buy with), but too frequently they add to the downward pressure by selling out part or all the stocks they own. Conversely, at other times, stock prices are pushed up far above real values by the understandable human tendency to buy when businessmen and friends are preponderantly prosperous and optimistic.

 

If an investor can sell out when the very top is reached and then buy back at the nadir of the subsequent stock market decline, he will indeed, grow rich quickly. But this can be done only by extraordinary luck. We have never found anyone who could forecast the rises and declines of the stock market correctly and consistently. Mr. Alfred Cowles recently completed a week-by-week study of the results which would have been obtained by following strictly the forecasting advice of eleven agencies which have published stock market trend forecasts throughout the 15 years from 1928 to 1943. He found that the forecasts were correct only 0.2 of 1 percent more than would be expected if the forecasts had been made just at random.

 

If no one can forecast the stock market trend accurately and consistently, how then, it may be asked, can an investment plan include the important element of shifting the balance between stocks and bonds in the fund? In answer to that question, this company developed in 1938, and put into practice, certain principles which make use of the major market fluctuations without attempting to forecast. Subsequently, such principles have become known as the “Yale Plan” or the “Vassar Plan.” The successful results of these principles in the management of those two college endowments are available in published sources.

 

In simplest terms, the “balance” of the investment fund is shifted gradually step-by-step away from stocks and into bonds when the stock market rises and then subsequently back from bonds into stocks when the market declines. The result is a moderate growth in the invested funds over each completed market cycle, without the need for any predictions of trends or turning points. An investment plan incorporating these principles assures you that you will be ready and able to buy stocks in periods of gloom when others are selling and that you will be selling when prices are reaching new high levels and optimism abounds.

 

Any sound long-range investment program requires patience and perseverance. Perhaps that is why so few investors follow any plan. Years may go by before the risks of haphazard stock purchasing are revealed by losses. And years may go by before experience proves the increased safety and enduring growth achieved by planning. Over a period of 20 years, however, it is not too much to expect that investment planning may cause the invested funds to double.”