Keys to Investment Success - John Templeton Reveals His Secrets

John Templeton is an investment counselor and Chartered Financial Analyst. Currently, he lives in Nassau in the Bahamas. Mr. Templeton is a Rhodes Scholar and holds a B.A. degree in economics from Yale and an M.A. degree in law from Oxford. He also holds honorary doctorates from Marquette University, Beaver College, Wilson College, and Buena Vista College. Mr. Templeton is the president of the Templeton World Fund Limited and president of the Board of Trustees of Princeton Theological Seminary. Mr. Templeton is a member of the International Academy of Religious Sciences and the author of The Humble Approach, published in 1982 by Seabury Press. He serves on the board of managers of the American Bible Society and the board of corporators of the Presbyterian Ministers' Fund Incorporated.

And he is also a trustee of Buena Vista College as well as a member of the Presbyterian Council of Theological Seminaries and the Mont Pelerin Society. For 20 years, his funds have been consistently top performers.

John, as you know, there are a number of analysts that say that in the next couple of years, we're going to experience another important top in the market, a major top. If you recall, between 1966 and 1974, anyone that had bought stocks during that period, especially if they had bought them at the 1966 top, they would have lost anywhere between 50% to 80% of their money, generally speaking. What do you advise to avoid this if a cycle top does occur over the next couple of years?

It certainly should be expected that we will have a cycle top within that length of time because the low point in terms of the market index is now almost three years ago. So it would be unusual to have an upward bull market lasting more than five years. But the question really is, if we do have a top, will it be an important top or just a small one? And my best estimate is that we have not had excesses. And because the prices have not risen to ridiculous heights, when the downturn comes, it may be surprisingly short and mild. In fact, I think you've taken a good period there, Joe, that from 1966 to 1974, the market was mostly downward, and 1974 was a very low point. Look at the 24 years before 1966.

From 1942 to 1966, there were no bad bear markets. You had a series of bull and bear markets, but each bull market carried up much higher than the previous bear market, so that share prices went up. From 1949 to 1966, which is 17 years, share prices went five times as high. Now, it's not at all impossible or even unlikely that that could be the same thing starting from 1982. If you start from where the indexes were in 1982 and look 17 years ahead, you may find that they're five times as high and that there has been no really serious bear market. Now, even a small bear market is something you can profit from if you know when it's going to happen. So in general, we find it pays better not to try to predict bull markets and bear markets, but instead just always buy whatever is the best value.

You search all over the world for any type of asset, doesn't have to be common stocks, but any type of asset, and find something that is selling for a small fraction of what common sense tells you it's really worth. And then you buy it and hold it, if necessary, throughout a whole market cycle. If you happen to buy it at the peak of, if you're buying a common share and you buy it at the peak of a bull market, you may have to wait for the peak of the next bull market. But you will make more money by doing that than you would if you tried to predict and were wrong in some of your predictions. We have been working at investment counsel for 45 years, Joe. We have never found any method to predict when the cycles would change that's accurate more than 60% of the time.

And we have never found any other organization with a record as long as 10 years in predicting market cycles that was right more than 60% of the time. And consequently, it's not wise to use that method. Don't try to predict the cycles. Instead, put your money in whatever is selling at a very small price in relation to its true value, and then wait patiently for it to be recognized by other investors and bid up in price.

Well, in your case, of course, that strategy is obviously proven to be absolutely correct. Now, what about the average investor, even if he does his research, not admitting that they actually made a mistake in a stock, and that they'll second-guess it, it'll decline, and they'll say, 'Well, everything's still all right, I'll hold on.' It declines a little bit further, and then they start to get worried, and then they're really starting to sweat, and then they say—the usual psychology is, 'Well, I think as soon as it gets... I can break even, then I'll get out,' right? But then it declines lower and lower, and then they panic at the very bottom and get out.

So what does a person do?

We think that if a person is just doing it for fun, they could try to do it themselves. But if they're really doing it to make a superior investment performance, they haven't much chance to make a superior investment performance if they're working only in spare time, as compared with an organization like ourselves, who works full-time and has a large staff of Chartered Financial Analysts working constantly. It would be truly surprising if some individual investor could make a better long-term performance than our mutual funds do.

Even though your method has been very successful, do you ever think to yourself, 'Well, gee, with the high inflation we have now and the volatile economy and the cycles and stocks seeming to be shorter and the roaring inflation, the government, the increased government control, and all the other factors that we have now, that the method that you've used may have to be modified or may be totally...'

One of the few things you can depend on, Joe, is that no investment method is going to be permanent. All investment methods will become obsolete, especially if they become too popular. When too many people are using the same investment method, it's already reflected in the market prices. So you have to continually seek for new investment methods in order to be in that method that other people are not using. The long-term success in investing depends on changing your method and changing from the method that has been most successful in the past into one that would have been least successful in the past in order to get into the one where there's not any competition.

Do you think your method is still unique or have you modified it in some way?

We've modified it continually for 45 years. We've continually had to modify our methods numerous times in order that we can try to stay ahead of the other security analysts because there are lots of intelligent security analysts and they're always adopting new methods. And when we talk to people like you and explain our methods, other people adopt them, and those methods then become obsolete. Once they're too popular, they're no longer useful, and we have to find new methods. So at any given time, we are experimenting with at least five, and often ten, new methods to see what type of new method we will find best for the next cycle.

What are you doing that's different in planning for the next four to five years?

We are studying every day and every month, actually at present, eight different methods that we may decide to use for the next market cycle. But the last thing I would do is to tell you what they are, because the success of them depends on having other people not use them. Out of all the different ways to select investments, the one that has lasted longest and probably will in the long run be the most likely long-term investment method is to buy the stock that has the lowest price in relation to value. The reason that's going to last is it's so difficult to determine the value. There are very few people who take the time and trouble to make a reasonable estimate of the value of a corporation.

It's so difficult and so time-consuming. And therefore, most investors just don't have the time or the knowledge or the inclination to make those valuations. The security analyst who does seriously try to estimate the values of every corporation and thereby the value of each stock is usually in the minority and therefore often finds stocks selling at as little as a quarter of what their true value is. So that method, over the 45 years we've been working, has been more useful than any other single method we've found.

Does the fact that your fund has a load to it, do you think, help to preserve the long-term record that you've had in the sense that it, in a way, disciplines your investors to maybe hold on, in some cases, when they would have sold out if they didn't have a load? Is that a factor at all?

Yes, it is, Joe. It would be a mistake for an investor to put money into any mutual fund for less than five years; you can't tell what the results are going to be in a shorter period. But if you look through the history of our mutual funds, you'll find there has never been a period as long as five years in which you wouldn't have made some money. Some periods you would have made more than others, but there has never been a five-year period in all of our 45-year history when you wouldn't have come out ahead if you left your money with us five years. Now, that bears out what you were saying, because if a person has to pay a cost of getting in, they are more likely to get in for a permanent holding.

You're less likely to attract somebody who's only going to be with you for a short while. But aside from that, I would say that let's take a concrete example. One of the directors of Templeton Growth Fund is named Leroy Paslay. And when we formed the Templeton Growth Fund 31 years ago, I telephoned my friend Leroy Paslay and said, 'Would you like to put $100,000 into our new fund?' And he said he would. And he's left that $100,000 there for 31 years, and it has now grown to $5,600,000. And Leroy Paslay doesn't worry a bit that he had to pay 8% or $8,000 for the privilege of getting in, when these 100,000 have gone to 5,600,000. Now, Joe, let me add another thing to that. And that is, I believe that the world should have mutual funds that have sales loads.

I really do not approve of funds without sales loads. And the reason is that the people who get that sales load are the representatives—the experts who go out and find people who don't understand stocks or don't understand funds or don't know how to invest. You have to have thousands of people who are paid a living wage to go out and carry the message to the people who need it. And the only way they can be paid a living wage is to get a commission on the mutual funds they sell. So the tens of thousands of mutual fund representatives and registered representatives of stockbrokers are doing a tremendous public service. They're persuading people to be thrifty. They're giving people more independence, more self-respect than they would have otherwise.

They are benefiting their customer much more than the cost to the customer for that small sales commission. But besides that, they are benefiting the whole nation and the world because they are adding to the total supply of available investments. And they are causing more people to be owners. At one time Karl Marx said that capitalism would collapse of its own weight because there would be less and less owners. But now, when I went into the mutual fund business, they had only 4 million owners in America. Now we have 44 million owners in America. And we're getting close to the point where most every worker is also an owner. And that's a very healthy thing. It's very hard to hate your boss when you're the boss yourself, you see.

So, the mutual fund representatives and the registered representatives of stockbrokers deserve and earn every penny that's paid to them. And I believe that all mutual funds and all investments should carry a load adequate to support the person who spends his time persuading you to invest in the right way.

John, what do you think are some of the most important lessons that you've learned in investing? Maybe you could share some of the mistakes you've made or point out the mistakes that you see that a lot of investors do make.

An ordinary investor will hear that X Corporation has a good outlook, and he rushes in and buys it. Now, nine chances out of ten, that's a mistake, because if it's obvious that it has a good outlook, the price already reflects that. And then if there should be any change in its outlook, the price will go down. So he's basing his investment selection on something that is misleading him, nine times out of ten. You have to buy those things that other people are selling, otherwise you'll never get a bargain. So don't ask yourself ever, 'Does this company have a good outlook?' Ask yourself, 'How cheap is it?' How low is the price of this stock in relation to earnings or future earnings or assets or dividends or sales volume or all these other things?

How cheap is this? How unpopular is it? If you find that you've found a stock that your stockbroker and other stockbrokers say, 'Oh, that's terrible. I wouldn't think of buying that,' that's the one to buy.

But let's take an example like the steel industry. Now, obviously, over the last couple of years, it's been pretty rough going, and a lot of people are saying that U.S. Steel is essentially finished. Now, if you were to decide to use contrary opinion and to buy stocks in the steel industry, how would you determine when you're really at that bottom? I mean, it could be now, it could be maybe five years. What do you use to fine-tune your timing on something like that?

Joe, as in most investing, we try to use common sense, and we do it this way, that we are constantly studying hundreds of individual stocks, thousands in fact, And we are trying to find that one whose market price is lowest in relation to value. Now, steel stocks have gone down in price, and they are lower than they once were in relation to value, but they have not yet gone down enough that they show up among our selections of the stocks that are lowest in relation to value. Now, value, of course, is a difficult thing to determine. You have to study as many as 100 different aspects of a corporation in order to have real estimate of its value. But we do that for the steel companies and we have it so far I don't think we have even one steel company in our mutual funds because none of them have gone down to such a low price that they are the best bargain.

Each time we do that, we find something else that's an even better bargain, and so we buy the better bargain. We will eventually find that some of the steel stocks are extraordinarily cheap, and we'll buy them, but they haven't gotten that cheap yet.

What do you think are some of the best areas over the next five years? Or maybe, using your method, we really shouldn't say areas. Maybe we should say, what are the best, let's say, four or five stocks for the next five years? Now, I know that for diversification, you'd always want a lot more than that. But I wonder if you could share a few examples and why you feel that they would be good.

The best investment is the one that has been thoroughly sold out by other people. Let's take an illustration. Union Carbide is one of the largest holdings we have. Union Carbide has had reduced earnings for several years and was unpopular even before the terrible accident at Bhopal in India. But because of the accident at Bhopal and the fact that many American lawyers sued them for billions of dollars greater than their total assets, Union Carbide went down recently to as low as $35 a share, which was the lowest it had been as far back as I have any recorded record of it. And yet it is a large, solid, well-managed company. And so we did buy more of Union Carbide because it was thoroughly unpopular, and it was unpopular for an obvious reason, that they had these enormous lawsuits to contend with.

And yet that's the time to buy. If you don't buy at a time like that, you won't get bargains. And so in picking a stock for the future, look around for something that has been extremely depressed, and then ask yourself, is there any good hope that it might eventually, in the long run, recover? And that's the thing to buy. Let's take the telephone company in Mexico. The telephone company in Mexico is down, the price of it is down to 40 cents a share, and it wasn't too many years ago when it was ten times that high. It's down to 40 cents a share because Mexico has great problems. The nation of Mexico doesn't have a balanced budget, the value of the Mexican peso keeps going down, the government doesn't allow the Mexican telephone company to raise its fees, monthly charges, enough to maintain the earning power.

And in Mexico, you can't get a telephone unless you buy shares in the company. So there's always a surplus supply of shares. People who need a telephone will buy shares, get the telephone, turn around, sell the shares, and push the price down. So the price of shares of a Mexican telephone are down to 40 cents a share, which is less than one-tenth what you'd have to pay for any other telephone shares. If you count the number of telephones in Mexico and the total market capital of the company, it's less than one-tenth of the capital of any telephone company in America in relation to the number of telephones they have. Also, Merrill Lynch, in their latest analysis of Mexican telephones, says despite these great problems, it will earn this year 30 cents a share.

And it's only selling at 40 cents.

I can understand your Union Carbide example, but in the case of Mexico, even though that might be a good value, isn't that really not speculating but more like gambling because of the political uncertainties?

Yes, it is. But there's no clear dividing line between investing and speculating. And the safest thing to do is to buy something that's already depressed. You're gambling more if you buy something that is popular and high-priced. But if you buy something that's already gone down to one-tenth its previous price, there's not much gamble left in it.

Well, with political uncertainty, situations like that, do you percentage-wise put as much into areas like that as you would into a really depressed stock that would be in the United States or in Singapore, someplace where the political climate is obviously secure?

No, no, that's right, you don't. When you're investing in something that may become worthless, you invest only a modest amount that you can afford to lose.

And you're just figuring on phenomenal returns if it works, more or less like buying a penny mining stock or something that's highly leveraged.

If you do this not just once in your lifetime, but if you do it dozens of times, many of them will turn out to make very large profits for you that overbalance those that failed. Joe, there was a time when I gave a stockbroker an order to buy every stock on the American Stock Exchange and the New York Stock Exchange selling below $1 a share.

I remember you telling me that.

And 37 of them were already in bankruptcy. And we bought a total of 104 stocks at $1 or less. And only four of them proved to be totally worthless. All the other 100 of them actually went up and we made a profit on them. And some of them we made 40 times what we put into them. So the willingness to buy things that are risky and are already depressed—don't buy something that's risky and is high-priced, but something that is already down to a tiny fraction of its previous value or its estimated value is not really speculating unless you concentrate. If you buy 10 of them or 100 of them, it'll turn out well. If you buy just one, you may lose it all.

Well, if a person, let's say, had $100,000 to put into stocks, approximately what percentage of a portfolio would you say would go into really speculative issues like that?

It depends on conditions, Joe. If you had looked at the list of holdings of our mutual funds in October 1974, you would have found over 50% of the holdings were that type. Because in October 1974, those were the bargains. The small companies, the unknown companies, the ones listed on the American Exchange, were so unpopular and so depressed that they were the great bargains. And we at that time had over 50% of our mutual funds invested in that type of depressed stock. Now, the small growth companies are popular. And so we have very few; among the—the shares of emerging growth stocks, we probably have no more than 10% now in our mutual fund. And we do own Mexican Telephone, for example, in our mutual fund, but it amounts to perhaps $110,000 of the value of our fund.

Because this is a time when low-priced young companies are too popular. There will come a time again when they're unpopular, and if so, we'll hold a lot more than we do now.

You sell on an average of four years. Is that correct, the average stock?

Not because we want to, Joe. When we buy a stock, we hope it'll go up next month and we'll make a big profit and get out.

It just turns out that way by coincidence.

But what we do is to buy the thing that is most depressed. And it's not usual that it suddenly becomes popular. Very often we have to wait a long time. Sometimes it's one month, sometimes one year, sometimes ten years. And even longer than 10 years. So we've kept a record, and it has averaged something over five years. It has taken five years for the thing that we thought was a great bargain to become popular again and rise to its true value. Then we got out and put it into a bargain at that time. We would like to shorten that period, Joe. We would like to find some way that we could make the same profit in a shorter time.

Do you have any simple techniques that you could tell the people how to evaluate stocks and how to determine especially when to sell?

Yes, I can say that. That's easy. Sell when you've found a much better bargain. Again, most investing is really simple common sense. If you look over your list of investments and you find something in there that could be replaced with something that's twice as good value, then replace it. But don't replace it if it's only a little bit better value. At one time in our work, we would replace a stock with another one that we thought was 20% cheaper. And we found we weren't right often enough. Now we wait until the thing that we buy to replace the stock to sell appears to us at least 50% better bargain. And even so, 30% or 33% of the time, a year later, we would have been better off to keep the old stock.

The very difficulty of switching from one stock to another is so great that we've never met anybody who made those choices and proved out better than two-thirds of the time.

Well, what do you do, though, when a stock reaches what you feel is its fair market value or maybe above it? How do you determine that? Are there any simple suggestions you can give to investors to determine that?

There's no easy way to judge the value of anything. Suppose someone asked you to judge the value of your hotel that you're in tonight. You would have a concept that is worth certainly more than a dollar, and it's worth less than a billion dollars, but somewhere in between is the value of that hotel. And to find out a reasonable estimate of that hotel, you would have to do a lot of studying. You'd have to find out what similar hotels sold for. You'd have to find out how many rooms there were, what it would cost to rebuild, what the rates are, what the trends are, what the management is like, on and on and on. So in order to arrive at a value of your hotel, you would have to spend a long time and ask a lot of experts.

And the same thing is true of valuing any corporation. So it's not an easy matter. And that's why it's a good way to use, because it's so difficult and so time-consuming, not many people do it. But that's the way you do it. You estimate the value of each of the corporations, which tells you the value of the shares. And then once you've done that, it's simple to buy that share that has the lowest price in relation to value. Then you continue to do that day after day, and you find some other stock that is an even better value. And if you find a stock that's a 50% better value than one you now own, you sell the one you own, put it into the new stock.

Let's take that $100,000 example again. Now, if a person had that sum of money to put into stocks and various investments, let's take the four basic areas that are normally suggested: money market mutual fund, bonds or bond funds, some form of hard asset investing, let's say gold shares or something like that, and let's say the Templeton Fund or some good diversified portfolio of funds. Out of those four groups, or maybe one other group that I didn't mention, approximately what percentages would you put into the various areas?

The answer would be different at different points in the market cycle and under different political and economic conditions. But as of today, the best bargains are in common stocks. Gold at $300 an ounce is already almost 10 times as high as it was 20 years ago. But stocks in general are up less than double the price in that same length of time. Real estate in general is a good investment, but it's hard to find a good piece of real estate that isn't at least five times as high as it was 20 years ago. But common stocks are, in general—American stocks and many other nations—they have gone up less than 100% in 20 years, so that today most of your wealth should be in those things that have not yet gone up. So for an average person—and each person should have different, uh, circumstances—

An average person should set aside in liquid assets, that is perhaps cash or money market funds, whatever they think they're going to have to spend within a year. And then above that, they should probably put it all into things that give them inflation protection, like real estate or common stocks. And out of that today, I would put 80% in common stocks and perhaps only 10% in real estate, because the bargains are in the stocks at present, not in the real estate. Now, that will change. It's quite possible that the stock market will double in value.

Well, I know you think that interest rates are generally trending lower. Do you feel that if you would still put 80% in the common stocks, you wouldn't put anything into bond funds or any other areas? You wouldn't keep some money in short-term Treasury bills?

I would keep in short-term Treasury bills whatever you think you might need to spend within a year. But if you're doing long-term investing, I don't think you should have anything in short-term Treasuries or even long-term Treasuries, because they give you no protection against inflation. And inflation is not over. We are having a happy period now of relatively low inflation, which may last a while longer. But in the long run, we think the next 10 years there will be greater inflation than there was in the last 10 years. So put your money into something that has at least some chance of protecting you against that inflation, which means either common stocks or real estate.

Harry Browne and a number of investment analysts that were very interested in precious metals in the '70s said that the reason why gold was at such a low level for so many years was because of price controls. Essentially, the government had it at a fixed price, and that the rise that we experienced was so dramatic because of the government releasing it. Therefore, if we're going to have heavier inflation ahead, which you yourself are predicting, they're saying that gold should go significantly higher. So if you're expecting higher inflation, why do you feel that no gold should be in a portfolio?

Because it's already gone up.

It's not a bargain, in other words. That's right. In other words, it's because the stocks relative to gold are a much greater bargain.

That's right, Joe. If gold had doubled in price, and stocks had gone up to ten times where they were, then you should get out of stocks and get into gold. It's just the other way around. The gold has gone up to ten times where it was, and the stocks are still only double where they were.

Why do you think it is, what you've said, your philosophy of investing—it's so logical, and probably if we had ten other money managers in the room, they probably would agree with most of what you said. Why is it that you have been so unique in the performance that you've achieved when most money managers would essentially agree with what you're doing? Is it that they don't do it, or is it that there's some flaw in their plan?

Well, you're very kind, Joe. We make so many mistakes that we feel very humble about our work. Really, it's a matter of hard work first. You have to work very hard. I have worked most of my life at least 60 hours a week, sometimes 80 hours a week, because you have to know so much and read so much and study so much. Hard work is a big part of it. Another thing is common sense, to keep it simple. Don't get carried away by a theory or a mathematical procedure. Just use common sense to say, 'Is this thing I'm buying really worth a lot more than I'm paying for it?' And then lastly, Joe, is patience. There are lots of people who lose money because they get frightened and sell at the wrong time, and they get overconfident and buy at the wrong time.

It takes a lot of patience to buy when other people have been selling for years. And then to sell when all your neighbors are buying takes a lot of patience. Self-control, perhaps, is another word for it. Then, of course, we also use prayer, Joe. Throughout our whole history, all of our meetings, shareholders' meetings, directors' meetings, and everything, open with prayer. And we pray not that the stock we bought will go up, but pray that we will use wisdom and common sense. We pray that we will make decisions that are beneficial to all parties. And it isn't the only thing you need to do, but if you do pray, you'll be able to think more clearly. You'll be less likely to be too tense or less likely to be mixed up in your thinking if you remember the eternal and permanent things rather than the excitement of the moment.

You've been involved in a lot of religious work and foundations. How did you happen to get so deeply involved? I wonder if you could share some of that.

I'd like that very much. In my opinion, again, it's a matter of common sense. If you ask yourself, what is it that's permanent? Well, the stock market isn't permanent. Your life isn't permanent. What is permanent? The permanence of spiritual things. God is permanent. If you ask yourself, what is infinite? Certainly, the price of U.S. Steel is not infinite, and you are not infinite. What's infinite? God is infinite. And so if you're really interested in those basic, fundamental, important things, you have to concentrate on spiritual things, religion in particular. In fact, I think you can go even further, Joe, and say that if you study it enough, you will realize that nothing really exists except God, and everything else is a temporary thing.

Small manifestation of that underlying reality which is God. Now, if you have that concept, you might say that cosmology, if you have the cosmology that everything else is temporary and small, then naturally you want to spend a large part of your time concentrating on things that are not temporary and small. And that means that whatever you do in life, you want to do in concert or in harmony with God's ongoing creative process. You want to do things that are helpful to everyone. And you want to be in a business that is beneficial to as many people as possible. You want to help as many people to think clearly as you can. So all of these thoughts have led me more and more, as I get older and I hope wiser, to think that I should spend more time helping people to grow spiritually and not so much time helping them to grow financially.

When did you arrive at this conclusion? Would you feel like you were always very spiritual? A lot of times people, when they face a crisis, tend to run into a brick wall of some type, come to this conclusion that there is a lot more to life than whatever they've been doing. Did you experience anything like that, or is this just a gradual unfoldment over the years?

Both. Both, Joe. Let's start on the first thing, that it is true that every human being has problems. There's nobody who doesn't have problems. Every human being has tragedies, has challenges. And that may be why God created the earth, because that is the way in which the spirit grows. If a spirit has no problems, no challenges, it does not mature. So we should be grateful for the blessings, tragedies, and challenges that every human being faces. Now, I've had my share in life, but from the very beginning, when I was a small child, I tried to look at things from the standpoint of what is eternal and what is infinite. Then, in working so hard 60 to 80 hours a week to try to select bargains for our investors, I didn't have much time in that week to think about permanent and infinite things.

So it was about 20 years ago when I felt that I had accumulated enough assets that I could afford to devote a major part of my time to the important things that I began to concentrate on helping people in every way I could think of to grow spiritually. So it was a gradual process. To simplify what I'm saying, for over 20 years in building an investment counsel operation, it was so time-consuming and required so much work that the important things got squeezed out by the urgent things. And during that 20 years, I got a stronger and stronger feeling that I was wasting my life on temporary things. And then I felt that now at last I can focus on those things that are not just small and temporary.

Then I gradually tried to help people to grow spiritually in a wide variety of ways. And as is normal in these things, Joe, when you try to help other people, you're the one who gets most of the benefit. If you start out to help yourself, you're not likely to achieve it. But if you start out to help other people, there is some magic or some law of the spirit that means that you help yourself.

It means law.

Yes, that we have tried to help people to hear about the marvelous new things going on in every religion by giving the Templeton Foundation prizes for progress in religion. And I believe we are helping millions of people to take religion more seriously. But in order to collect that information and submit it to the Board of Judges, my wife and I have had to study and come in contact with the world's most marvelous people. And so we have learned more and benefited more than anyone by trying to help other people. The same thing is true in smaller matters, Joe. If you try to help shareholders to produce a good investment result, then instead of having 100 shareholders, we now have 370,000 shareholders, which is a great benefit for us.

John, we've talked a lot about the investment do's. We've mentioned a few don'ts. Are there any that we haven't mentioned that you think are important?

To avoid investment mistakes, the most important thing is to avoid buying those things that other people are buying, and to avoid selling those things that other people are selling. When we started our investment counsel organization 45 years ago, we printed on our booklet a motto which would answer this question. It said, 'To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.' You have seen this in your life, and your readers and your listeners have always heard that people tend to buy things after they've already gone up, because they wish they had bought them in the past. Like gold, for instance.

You didn't find many people anxious to buy gold at $35 an ounce. But when gold got to $500 an ounce, there were thousands of people buying gold because they heard their neighbors made a fortune in it and they wanted to get in on it. And that was the wrong time. The time to buy anything is when other people are not buying it or selling it. The same thing has happened in the stock market almost every year. In 1983, the high technology stocks were extremely popular. And it was true that the industry is rapidly growing and very exciting. There is a great future for communications technology and for computers. But as a result, people rushed in and bought stocks of small, young companies as high as 40 times earnings and some of them 60 times earnings without even bothering to find out what the earnings were.

They were carried away with the concept that great technology was the wave of the future, which it is, but they paid too much. And the average technology stock is 50% cheaper now than it was two years ago, and yet it's not cheap enough yet, even yet, to be a good bargain. There are very few bargains in the high technology area because it is not yet fully unpopular. This is just one of many illustrations, Joe. I remember one time anything to do with uranium was magic. Any company that had uranium in the name or nuclear in the name would sell for 40 times earnings. But now they're the most unpopular. And if you ever want to invest in things nuclear, now's the time to do it when you can buy some of the electric utilities in the nuclear business for five times earnings instead of 40 times earnings.

The same thing happens over and over again in all forms of investing, whether it's an industry, a nation, or whatever.

What are some of the areas that you feel are out of favor now?

It would be a wide variety of things. Some of the industrial companies in Sweden are out of favor now because of the socialist government in Sweden. The socialist government has put on new taxes and required corporations to sell shares to their own employees, and so that stocks like ASEA or SKF or Sandvik, those great Swedish companies that are worldwide and very strong, are down to very low prices, selling for less than five times what they'll earn this year, and selling perhaps no more than three times what they'll earn five years ahead. So it's a very depressed area, and some of the great bargains in the world are in that area now. Another illustration might be in lumber. Lumber has been selling at a very low price now for over a year.

So the companies that make and sell lumber are thoroughly depressed in price and have not yet started to go up because the outlook for lumber is still bad. There's still a surplus of lumber and still weakness in the price. Still, many lumber companies are operating at a loss. But by the time that begins to look better, then the prices will have already gone up. So this is a good time to find bargains in lumber companies.

For people that are in the high tax brackets, a number of analysts say that with the high yields that we've been receiving in interest rate vehicles, that it's good to put money into a pension fund, or let's say have them in your municipals or whatnot, and by the rule of 72, your money's going to double, you know, depending on what the interest rate is—you know, let's say 10% in approximately seven years. And they say that this is, in the type of environment that we're in, that for a lot of people this is the best way to go. So what's your feelings on that?

I thoroughly agree. It's the best way to go—to put your money into something where you're not held back by taxes. It was only two years ago that Americans were given the privilege of setting up their own private pension funds in addition to whatever their employer might provide. They could set up an individual retirement account, or IRA, and 107 million Americans are eligible to do that. And already 135,000 have started IRAs by investing in the Templeton Group of Mutual Funds. And that is the best possible type of investment because it makes a huge difference in your ultimate results whether or not you have to pay taxes while you're investing. You have there on the table a little leaflet that shows that if a person had started an individual retirement account in the Templeton Growth Fund 30 years ago, by putting in $2,000 a year over a 30-year period, they would have put in $60,000.

But because of the tax law, they could have subtracted that from their top tax brackets. So it might have cost them net after taxes maybe less than $40,000 to start the individual retirement account and keep it there for 30 years. But because all the dividends and interest and gains accumulated tax-free in this individual retirement account, they now have over a million dollars.

Well, since it's in a retirement account where it's tax-free, and you get that cumulative effect of the doubling of your money in, let's say, ten years or seven years if it's at 10%, should any of it be in bonds or in interest rate vehicles, or would you still say 80% in... in, let's say, the Templeton Fund or a diversified group of stocks?

Where you have a way to invest free of taxes, it's not so important to concentrate on capital gains. If both the capital gains and the interest and the dividends are all tax-free, then they're all equally important. If you're investing for a taxable person, then it's much better to focus on getting gains rather than dividends and interest, which are subject to higher tax rates. But in general, we would recommend that even the tax-free individual retirement accounts ought to be mainly in common stocks now, because that's where the values are. It's quite possible that the values of common stocks will double in the next five years. Now, if that happens, then at that time, maybe you would be wise to sell out the common stocks and buy high-yielding bonds.

If we have inflation at that time and bonds again are yielding high amounts as they did a few years ago, buy them. So at any given time, buy whatever is the best bargain. But right now, the best bargains are in common stock.

What do you think of zero-coupon bonds for, let's say, for providing for children's education or some type of a long-term investment situation?

Very good. Zero-coupon bonds serve a very useful purpose, and I would recommend that lots of people buy them, especially for their tax-free funds. Because, as you know, the American government taxes you on the accumulation, even though you don't get it. You may get nothing out of the zero-coupon bond, but the government makes you put it on your tax return as if you were getting that rate of interest. So you pay a tax without receiving any money with which to pay the tax. But if you put your zero-coupon bond in a tax-free fund, like an individual retirement account, then you get the full advantage. And you can buy some of the zero coupons of the highest quality now to yield over 11% to maturity.

And as you point out, 11% will double your money every six years, or six and a half years. And so if you leave it in there long enough, you will have a very fine result. But I'm not doing it. And I'm not doing it because I think I'll do better with common stocks. In a zero-coupon, high-quality bond, I might get 11% a year. But I think in common stocks, I may get from capital appreciation alone 18% a year over the next five years. And in addition, perhaps 4% a year from dividends. That brings me up to 22%. Then in addition, if I have good sense or have a good advisor to select common stocks that are better than others, I may add up as much as 5% of what we call the skill factor. So by selecting the better common stocks,

I may wind up with 27% a year return on my common stocks instead of 11% a year on my high-quality zero-coupon bonds. And so under today's conditions, I do not buy zero-coupon bonds. But that's temporary. There may come a time when stock prices are too high, and when they are, then maybe zero-coupon bonds at that time will be the world's best bargains.

Which is the most aggressive of your funds? In other words, which one would you say should have the greatest appreciation and also probably the greatest degree of risk over the next five or six years?

The one that has the least risk is also likely to be the one that produces the best results.

And that's because it's called the Templeton World Fund, and it gives us complete discretion to invest wherever the opportunities are, and no restrictions. We can invest in any nation, we can invest in any type of security, any industry, small companies, large companies, or whatever. And so it puts on us the burden of finding the best bargains of any type, anywhere. And I think that freedom to find all bargains will result in a better long-term record. And I believe also in more safety because it will be better diversified. As compared, for example, with a fund that we offer to the public called Templeton Global Fund, which is restricted to investing in small corporations. Now there's a lot of merit in investing in small corporations, and we do find some good values, and I do believe that that will pay well to the shareholders.

But remember that it can only look for bargains in one area, only in the small companies. And we have to exclude bargains in other areas. And look also at the fact that sometimes shares of small companies are not cheap. But in this fund, we'll always have to keep it in shares of small companies. So because of those restrictions, I would say it's more risky than the fund that gives us unlimited opportunities, and at the same time I think it'll produce in the long run less results than the one that gives us unlimited field to search in. We also offer, Joe, a fund called Templeton Foreign Fund, and that is the same as the unlimited Templeton World Fund, except we promise not to ever buy an American stock.

And this pleases some of our clients, particularly big pension funds or charities who've decided it's their duty to invest 10% outside the United States. If they put it in the Templeton World Fund, some of it's in the United States, but if they put it in the Templeton Foreign Fund, it's entirely outside. And so it's a rapidly growing fund that serves a useful purpose. But I'd be surprised if in the long run they could make as much money by limiting us to the rest of the world as if they limited us to the whole world. And so to answer your question, I believe that 90% of the ordinary people would be better off in the Templeton World Fund rather than our Canadian fund or our small companies fund or our foreign fund.

Is there anything that you can think of that we've missed that you think would be really perhaps the most important rule that you've learned in investing or some important message that you'd like to convey to people in managing their investments over the next five years?

Yes, Joe, I would like to say that I believe people should save more. It doesn't do any good to be a good investor unless you have assets to invest. And Americans are not saving anywhere near as much as they should. When I was a child, people had a mortgage on their home. They wouldn't tell anybody because it was some sort of a disgrace to owe money on your home. Now almost everybody has a mortgage on their home. We should get back to the concept of thrift, where Americans, instead of saving now roughly six cents out of each dollar they earn, they should save 25 cents out of each dollar they earn. In Japan, people are saving now about 25% of each dollar they earn. That's one big reason why Japan is forging ahead twice as fast as the United States.

In Germany, people save over 20 cents out of what they earn. And Americans should get back to that, because if they save that money and then they use common sense in their investments, it will build up into a very wonderful fund. Thrift is a greatly neglected virtue in America, and we should do what we can to revive it.

Do you think that this lack of thrift is at the root of some of the problems that we've had? Oh, yes.

It certainly is, Joe.

In other words, it's that psychology that pervades over into our government.

Yes. It's the attitude that the government has an unbalanced budget. The government spends more than it takes in. That would not have been possible 60 years ago. The public wouldn't have stood for it. Now the public is willing to put up with it. In fact, the public complains if they try to balance the budget. And the same thing happens to individuals. Most individuals now are spending more than they earn. And many corporations are spending more than they earn. And this is all having a very bad effect. But the bad effect it's having is inflation. That when this happens to a nation or a people, in the long run they will pay for it in the form of inflation. And so that means that if you do have some wealth to invest, invest it in those things that give you some hope of inflation protection.

In that regard, as you know, there are a lot of analysts that say that we're not going to be able to get out of this without some real painful periods. So far, with the inflation that we've had, has not really caused any severe economic problems. We've had a recession, but certainly no depression. And with the Reagan administration in there now, everybody is generally rather hopeful that we've licked the problem. Now you're saying we're going to have more inflation. Do you feel that we'll gradually liquidate these debts through a process of periods of up and down inflation and get through the decade without any severe downturn? Or do you feel like that eventually we will have to have some type of major contraction to liquidate those that have vastly overextended themselves?

I do not think in America we will ever have a year of deflation. I lived through a period from 1929 to 1932 when the cost of living went down 20%. But the attitudes were totally different then. People didn't think it was the duty of the government to stimulate the economy. There was no Social Security. There was no unemployment insurance. There were no guarantees of bank deposits, and on and on. Now our attitudes are so totally different that if we even get close to a deflation, the public demands the government do something about it. If a bank is about to fail, at least a big bank, they demand the government rescue them. And all those rescues are inflationary. So that I don't think you'll ever see a year in your lifetime, or mine, in which there will be a year and it will cost less to live than it did the year before.

And my best estimate, and it's just that you could make your own estimate, but my best estimate is the cost of living will double in the next nine years and will double each nine years after that. So if you're talking 36 years ahead, it'll cost 16 times as much to live as it does now.

John, it's been a pleasure to have you as a guest on Investor's Hotline.

Thank you, Joe. Glad to be with you again.