How Investing Transformed Over the Century

April 12, 2017

I recently read a book on the sinking of the Lusitania in 1915. The author thoroughly details the lives of some of the affluent passengers who were aboard the luxury liner’s final voyage. As I was learning about these “high net worth” people who lived one hundred years ago, I kept wondering about how they saved and invested, and how early 20th century investing contrasts with early 21st century investing.

The 1915 investor had only limited options for investing excess cash. The easiest method was to deposit the savings in banks and earn a fixed rate of interest on the balance. Unfortunately, banks went through periodic cycles of failure where depositors would partially bear bank losses. The FDIC, which insures bank deposits, was not created until 1933 so depositing money into bank accounts carried an uncomfortably high risk of loss for some depositors.

Today’s investor can sleep easy at night knowing that the funds held in his or her bank account are safe and secure. Bank deposits are now insured up to $250,000 and there have been no losses to depositors in many decades due to bank failures. In exchange for a very liquid and risk-free account in the bank, however, today’s investor will receive only modest rates of return on their savings.

NY Stock Exchange
NY Stock Exchange, early 1900s

If investors in 1915 wanted to earn higher returns than the banks would pay, they could invest in some corporate bonds (mostly railroad and utility). But there was little regulation of these bond issues so there was a significant risk of default. Government bonds were not yet available since the U S Treasury did not start issuing bonds until 1917 to help fund World War I.

Today’s investor has a much wider variety of bond choices. In addition to government bonds, investors can purchase corporate bonds, municipal bonds, mortgage-backed securities, and asset-backed securities. Fixed income investors can also purchase bond funds which represent an investment in a pool of individual bonds.

Investors in 1915 might have owned gold and silver coins, nuggets, or bars. They probably looked at these precious metals more as a medium of exchange rather than as an investment. Precious metals are expensive to store and secure, and do not generate any investment income. Without the ability to produce cash flow, precious metals are unable to satisfy investors’ essential need for income from their investments.

The most common investment owned by investors 100 years ago would likely have been real estate. During the first few centuries of our country’s history, much of the country’s wealth was tied up in real estate, whether it was productive agricultural property or homes and buildings that could produce rental income. Unlike cash in the bank, real estate was not particularly liquid and probably generated returns that were subject to the volatility of economic cycles. This probably meant that real estate income was not particularly consistent or stable.

Today’s investor likely has a significant portion of their total net worth tied up in their personal residence. Ownership of residential real estate does not normally produce any income, and instead yields a negative cash flow due to taxes, insurance, and other maintenance expenses. Nonresidential real estate can generate acceptable returns, but debt also normally accompanies these real estate investments, which means only the most creditworthy borrowers can get the loans necessary to own income producing real estate. And as we saw in the last financial crisis, while leverage can boost returns in stable and rising markets, it can also create significant problems when markets seize up.

Investing in the stock market was an investment option one hundred years ago, but stock ownership was probably not very widespread among most savers. Investing in the stocks of publicly owned businesses most likely represented a higher risk investment than bank accounts, real estate, or gold. The New York Stock exchange was founded in 1817 so by 1915 it had been in existence for nearly 100 years. Despite that mature operating history, there was still a speculative element to investing in stocks in the early 20th century. Securities regulation was mostly nonexistent and stock market price manipulation could occur more easily than is possible today. Securities trading was especially prone to panics and crashes during this period. Ownership of both stocks and bonds was evidenced by paper certificates that were not particularly easy to transfer, and subject to loss by being misplaced, destroyed, or stolen.

Compared to other global economies, the U.S. stock market was the big winner in the 20th century. From 1900 to 2000, the U.S. stock market’s weighting increased from 22% to 47% of the world’s total. Another distinct evolution in the U.S. market was the transition from 20 to 30 different regional exchanges (which focused primarily on the industries prevalent in their areas) to concentrated financial centers (NYSE, Nasdaq). Finally, we have seen a huge sector rotation, from an investor obsession with railroads at the end of the 18th century to an investment focus on information technology, banks and finance, and pharmaceuticals by the end of the 20th century.

Today’s investor has investment options that the 1915 investor could never have imagined. Anyone with discretionary capital can easily invest in a large and diverse selection of successful businesses. Businesses can compound growth annually (generate earnings which can be reinvested) so that over long periods of time, an investor can grow his or her original investment many times over.

Opening a brokerage account to buy and sell securities can now be done quickly and easily, allowing savers to invest around the world 24/7. As pensions declined in popularity over the past few decades and 401k plans took their place, Wall Street designed even more solutions to facilitate the investment in securities. Wall Street has securitized virtually every asset so that investors can easily buy and sell such formerly illiquid assets such as real estate and precious metals within their brokerage account. Investments can be made directly in a company or in a pool of companies through a mutual fund or exchange traded fund.

The past 100 years have seen incredible growth in ownership of publicly traded securities by a large portion of the American citizens. Back in 1915, there were fewer blue chip stock investments. The Dow Jones Industrial Index was comprised of only 12 companies, most of which were in the industrial sector. A glance at the 30 companies comprising today’s Dow Jones Industrial Index reveals a cross section of businesses that operate in a wide variety of economic sectors. Prosperous businesses create extraordinary amounts of wealth, and investors benefit immensely from being able to own, either directly or indirectly, successful and thriving businesses.

The last 100 years have seen a huge transformation in the “who,” “how,” and “what” of investing. Investing has been democratized, open now to virtually anyone for any amount. Rather than holding hard assets which were largely illiquid and difficult to store or maintain, today’s investor holds highly liquid, publicly traded securities evidenced by electronic means. The investment universe has multiplied exponentially.

 

AUTHOR:

MALCOLM BUTLER, JD