John Maynard Keynes, Value Investor
Memorandum for the Estates Committee, Kings College, Cambridge, 8 May 1938
…In fact the chief lesson I draw from the above results is the opposite of what I set out to show when, what is now nearly 20 years ago, I first persuaded the College to invest in ordinary shares. At that time I believed that profit could be made by what was called a credit cycle policy, namely by holding such shares in slumps and disposing of them in booms; and we purchased an industrial index including a small holding in an outstanding share in each leading industry. Since that time there may have been more numerous and more violent general fluctuations than at any previous period. We have indeed done well by purchasing particular shares at times when their prices were greatly depressed; but we have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle. In the past nine years, for example, there have been two occasions when the whole body of our holding of such investments have depreciated by 20 to 25 per cent within a few months and we have not been able to escape the movement. Yet on both occasions I foresaw correctly to a certain extent what was ahead. Nevertheless these temporary severe losses and the inability to take substantial advantage of these fluctuations have not interfered with successful results.
As the results of these experiences I am clear that the idea of wholesale shifts is for various reasons impracticable and indeed undesirable. Most of those who attempt it sell too late and buy too late, and do both too often, incurring heavy expenses and developing too unsettled and speculative a state of mind, which, if it is widespread, has besides the grave social disadvantage of aggravating the scale of the fluctuations. I belive now that successful investment depends on three principles:
(1) a careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probably actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;
(2) a steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake;
(3) a balanced investment position, i.e. a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g. a holding of gold shares amongst other equities, since they are likely to move in opposite directions when there are general fluctuations).
On the other hand, it is a mistake to sell a £1 note for 15s. [CR: 75 pence in modern terms] in the hope of buying it back for 12s. 6d. [CR: 62.5 pence in modern terms], and a mistake to refuse to buy a £1 note for 15s. on the ground that it cannot really be a £1 note (for there is abundant experience that £1 notes can be bought for 15s. at a time when they are expected by many people to fall to 12s.6d.).
Another important rule is the avoidance of second-class safe investments, none of which can go up and a few of which are sure to go down. This is the main cause of the defeat of the average investor. The ideal investment portfolio is divided between the purchase of really secure future income (where future appreciation or depreciation will depend on the rate of interest) and equities which one believes to be capable of a large improvement to offset the fairly numerous cases which, with the best skill in the world, will go wrong.
