American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

May 2002 – Spend from Capital

The story is told of a female member of a proper Bostonian family who was picked up by the police for streetwalking. At the urgent family conference that followed, the head of the family asked:

“Emily, how could you do such a thing?”
“I needed the money,” she calmly replied.
“But your father took care of you in his will, why didn’t you use that
“Why, that would be spending out of capital!”

Old investment dictums die hard. Many investors still cling to the notion that spending from principal runs contrary to the notion of building wealth. The rule was born during an era of sound money, when an investor could assume that when he recovered the face value of a bond at maturity he could be relatively certain that the purchasing power of the proceeds would not be diminished from when he first purchased the bond.

Wise investors have since shifted to common stocks, gold, and other assets as a hedge against price inflation. Yet if one refuses to sell common stocks or gold coins in order to avoid spending from capital, he would be contradicting the very reason these assets were purchased in the first place.

In the current environment, with interest rates low and price inflation mild, investors should resist the temptation to “reach for yield” by purchasing fixed income assets with long maturities or lower credit ratings. Should price inflation accelerate with a commensurate increase in interest rates, they will see the value of these securities drop rapidly. Everyone’s circumstances are unique, but it is often better to spend from capital, even if it means liquidating assets at a modest but certain loss, than to assume the risk of a substantial loss in the near future.

Also in This Issue:

Evaluating the Research of Historical Performance
The High-Yield Dow Approach: Investment Methodology
Small-Cap Stocks: An Update
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield