The Financial Plan

Give me some kind of content to remember how painful it is sometimes to keep money, as well as to get it.     —samuel pepys' Diary

INTRODUCTION

The preceding discussions have outlined the characteristics of a number of different channels for investment. Only two of these, life insurance and home ownership, are obviously part of a long-range investment plan. For short-term sav­ings, it might be prudent to place funds in sev­eral different places of deposit such as savings banks and certain of the savings and loan asso­ciations. By this means one obtains, in addition to maximum protection, the advantages of diver­sification by not placing "all the eggs in one basket."

Suppose that a "rainy day" fund has now been accumulated and that, in addition, a reasonable amount of other funds are available. What is to be done with the money? Should it simply be al­lowed to remain in comparatively safe sur­roundings and be compounded at a low rate of interest, or are there other investments in which it may be employed to much greater advantage? For many persons, the placing of funds where they earn interest constitutes investment. They are quite willing to do nothing more than to tuck a passbook in a bureau drawer or to place a few bonds and stock certificates in a safe-deposit box, and then forget about them. They make no attempt to formulate an over-all finan­cial policy which will be a general guide in the administration of their funds.

This undiscriminating procedure is to be re­gretted, because it cannot lead to maximum financial benefit. For example, the man who makes no attempt to see the relationship of a life-insurance program to the total investment policy may, by this oversight, find himself tied to an insurance program which is not suited to his needs. Actually, investment in life insurance should be recognized as only a part of the broader aspects of a general financial plan. Life insurance is, in itself, a highly desirable invest­ment, particularly for a young man who is just launching his career and wants protection plus the added advantage of building up an estate, but some attention should be paid to other forms of investment and their interrelationship. Other factors to be taken into consideration are the current rate of return and the final objective to be attained, which may be current income, the creation of an estate, and even some gradual appreciation of the principal itself.

The formulation of an over-all financial plan should apply to all investments, so that any given investment may be carefully explored and its merits weighed in relationship to the whole. The problem is a knotty one, because there are many factors which enter into it. However, when each of these factors is carefully defined and a statement of objectives carefully worked out, it is possible to arrive at a satisfactory solution. Of course, the decisions to be made are not to be considered lightly, because in their details they may possibly be the most important to be made by any investor during his entire lifetime. It is true that such a plan may be subject to modifi­cation as time passes, and this is as it should be, since circumstances alter cases; but the face-to-face realization of the importance of invest­ment for a lifetime has a rather sobering effect, inasmuch as it causes one to come to grips with matters which are of paramount importance to him throughout his entire productive years and which will have an indirect effect upon the lives of all members of his immediate family.

THE APPROACH

Let us suppose that Mr. John Q. Citizen has a fair degree of protection for his family in the form of life insurance and is purchasing a home as well. Besides, he has accumulated additional funds, some of which he has set aside and ear­marked for emergencies; the rest he wishes to invest in other media. There will be a number of factors he should investigate.

Too often such a person depends upon chance information, so-called "tips," in making such a decision. He must realize that if he applies his intelligence he will learn more, know more, have better judgment, and also find out those sources of information and guidance that are best able to serve him. Many financial officers, whose sole business is to assist others to the best of their ability, find that not a few clients adopt a "know-it-all" attitude and seemingly do not wish any additional assistance. What is needed is a certain amount of education in the field of finance and investment. This cannot be achieved in a few days or a week, or even a month, but requires long and patient study; however, it will pay off in the long run, far better than any hit-and-miss method.

Let us suppose that Mr. Citizen has been read­ing the financial pages of a newspaper and has some rather vague ideas of such things as safety, liquidity, and rate of return. His first mistake is likely to be to suppose that there is such a thing as an ideal investment, which will guarantee him highest safety, immediate liquidity, and a rather attractive rate of interest coupled with very promising growth possibilities. Where will he find this? Nowhere! If there were such a thing, all people would be fully invested in it, and all other forms of investment would lan­guish and die from lack of patronage.

Before discussing the establishment of a fi­nancial plan, we must first define three terms which are in common use; unfortunately, they are often used interchangeably, although they are by no means synonymous. They appear in practically all the literature of investment, and the reader should become very critical of their correct use:

1. Investment is the placing of funds with a view to obtaining income and/or profit thereby, where risks are relatively easily evaluated and minimized. Example: the  purchase of  U. S. Savings Bonds.
2. Speculation is the placing of funds in a venture where the risks are more substantial and are less readily appraised. Example:  the purchase of stock in a new industry, such as electronics.
3. A gamble is a monetary hazard wherein the risks are largely subject to chance. Examples: stocks involving mineral wealth where no satisfactory appraisal has been made; wager on the turn of a card.

Many persons are so unfamiliar with the dis­tinction to be made between these terms that they think they are investing when they are really speculating and sometimes (although they would be unwilling to admit it) they may even be gambling. In all fairness, it must be acknowledged that it is often difficult to dis­tinguish between investment and speculation. An accurate evaluation of risk is not always eas­ily obtained, since many intangibles are often involved. It would be the best and safest policy to regard any investment as a speculation until sufficient evidence shows definitely into which category it should be placed. As a rule, there are authorities (such as securities analysts and investment houses) whose business it is to make such evaluations, but our Mr. J. Q. Citizen can­not be too careful and should obtain all possible information pertaining to any particular invest­ment. He certainly cannot afford to gamble, and it is a serious question whether he can afford any sort of speculation in which the degree of risk is high. This is best illustrated by the fact that a man with $100,000 can afford to speculate with $1000, for that is but 1 per cent of his total available funds; but Mr. Citizen, with perhaps $1000 in the beginning, can scarcely afford even to take a great risk with $100, for that is 10 per cent of his available capital! The moral to be drawn here is: never speculate when you cannot afford it! This means that the so-called "cheap stocks" are especially to be avoided, since the degree of risk is extremely high. Their cheap­ness reflects the risk involved.

The best forms of investment, carrying the lowest risks, will always pay the lowest rates of return, and anyone who insists upon any higher rate must be prepared to accept some sacrifice in quality; compare high-grade bonds with aver­age grade stocks, for example.

BASIC CONSIDERATIONS

In order that any investment program shall be reasonably certain of success, there are a num­ber of features that must be evaluated and con­sidered. It is only natural that we consider them carefully, because the program itself must be tailored to the needs of the individual.

The first factor is the age of the individual in­vestor. A man between twenty-five and thirty-five years of age would have an entirely different set of investment objectives from a man in his fifties. The younger man will look forward to the building of an estate throughout the years, as his earning power increases. He probably will be more interested in "growth" securities, while the older man may place great emphasis on safety and current income. Next would probably come the state of his health, since a lack of sound health would perhaps threaten to curtail his earnings, and this in turn might dictate a type of investment program which would em­phasize safety of principal above all else.

The number of dependents and their require­ments will certainly have a bearing upon the objectives to be attained by any program, since such matters as food, clothing, shelter, and gen­eral living standards will be reflected in the total family budget, and this in turn will relate to the total available funds. For example, Will Windowglass has a wife and three children, while Lawrence Lawnmower is married and has no children; it is quite apparent that the former will carry quite a sizable amount of life insur­ance in his over-all program, while the latter may find other forms of investment more attrac­tive and more suited to his needs. Other things being equal, Will can scarcely match the total amount that Lawrence will have available for investment, since the latter has fewer family responsibilities.

The individual temperament of the investor is quite important. Some people worry about any risks, regardless of size; some worry about things that might happen and could cause dis­aster. Such persons should place their funds in investments that promise the highest degree of safety, such as good-quality bonds; they would never be happy otherwise. In the field of invest­ment, as in all other cases where risks must be assumed, there is no place for the man who tortures himself when he takes them. Peace of mind is far more important!

Economic status determines in advance the funds that the investor may have available. Some occupations may allow only a modest degree of financial improvement throughout life, which will, in turn, limit the range of one's invest­ments. Other occupations may place no obstacles in the way of continual financial gain, coupled with still greater future possibilities in the field of investment. A wealthy individual will be con­cerned over the taxation factors, as much even as he may be with the income itself, while those of more modest means will be satisfied with an entirely different set of objectives in setting up their financial program.

One other important aspect should not be over looked. This is the education, background, and general understanding of financial matters. To have an optimum amount of these is, of course, desirable, but it does not follow that their lack will make it impossible to become a successful investor. If Mr. J. Q. Citizen is willing to educate himself patiently in this field, he may expect to enjoy a reasonable degree of success. Nevertheless, "fools rush in where angels fear to tread" is a saying long to be remembered by any prospective investor. Education, training, and experience may be had by anyone who has the determination and the patience, and they will assuredly produce results. Adult-education courses may help, and most good brokerage houses are willing and eager to help a prospec­tive client. Many of them distribute helpful ma­terial for the asking, and there is a very con­siderable literature in the field. (See Appen­dix A).

Aside from personal factors, there are certain orderly steps to be taken toward possible success in the investment field. These may be summa­rized as follows:

1. Surplus funds must be accumulated, since no investments are possible without them. With proper planning this may be done; at the same time, though it is a means to a desired end, it should be carried out within reason and should never become a burden.
2. An over-all investment plan, the details of which are set forth in the section to follow, must be formulated.
3. Supervision is continually required in order to realize one's objectives. An investment program cannot be successful if you place securities in a box, turn the key, and then promptly forget them. Constant vigilance is necessary to preserve the program and to make it succeed. This means the continued study of economic conditions, political and social developments, financial reports, the behavior of the business cycle, taxation, and money rates. Most  of  the larger daily newspapers carry a financial page, the continuous reading of which is quite valuable in keeping up to date with developments in the field of current finance, while numerous magazines provide opportunities to keep abreast f the times in this and other fields. Constant review is necessary. Securities should be sold when strong   quantitative    and/or qualitative evidence dictates. Each security, no matter of what kind, presents its own problem, and all information which may have a bearing upon its investment soundness should be obtained where possible and should then be considered objectively. As   investment  program   is   never  completely static and must be subject to change; it is not always possible to predict or evaluate completely the risks involved, since changes in economic, political, and social conditions may pose the need for new evaluation of any given security and a review of its current and future prospects.

The social aspect of investment has shown many remarkable changes. For example, after the great crash of 1929, the stock market was viewed with considerable distrust; but the far-reaching reforms made shortly afterward have brought about an entirely new attitude toward common stocks as an investment medium. An­other example of a change in social attitude is in connection with bonds. The strong promo­tion of U. S. Government Bonds (Savings Bonds) during World War II and afterward has educated the public in the feeling that bonds are not only for the well to do, but may be owned by anyone; actually, these bonds were es­pecially tailored so as to be within reach of the small investor.

The few guiding principles set forth above may easily be followed by anyone, so that he may institute a program and follow it with a rea­sonable degree of success. We will now turn our attention to the basis of the program itself.

ELEMENTS OF THE PLAN

The prospective investor not only must ap­praise his own personal factors, but he must care­fully define his objectives before he can make a beginning. This means that he must come face to face with his over-all needs as related to de­gree of risk, rate of return, possibilities of growth, marketability, and liquidity. For exam­ple, a young investor will more likely stress growth at a sacrifice of return, while a middle-aged person will place greater emphasis upon adequate current income. As one elderly in­vestor so well and so tersely said: "Of what use is the growth factor to me when I am not even sure that I will live to see the growth accom­plished?" Lifetime objectives such as travel, re­tirement, estate building, establishment of a trust, needs for current income, and the like must all be considered.

The reader may well ask if all such objectives may be realized simultaneously. The answer must be a qualified one: perhaps. As we shall see shortly, each investment has associated with it certain investment characteristics which may or may not make our objectives possible of achievement. For instance, the "growth fac­tor," which simply means the increase in the value of the invested principal with the passage of time, is the most difficult of attainment and very likely will entail the most risk. In our de­velopment of an investment program we will first proceed on the assumption that Mr. J. Q. Citizen may very well do without this objective, and we will then show how his program may be modified later to include it.

The first objective of the program should be to minimize risk by means of the basic, time-tested principle of diversification. All writers in this field agree that, while there is no magic formula to eliminate risk completely, diversification, when properly utilized, will greatly mini­mize it.

In order to see just how this may be accom­plished, it is now necessary to discuss the various types or classes of investments in general. Each of them possesses certain qualifications from the investor's point of view, and every investor should be aware of the advantages and disad­vantages of each of them in order that he may intelligently consider their usefulness to him.

1. Bonds   (including U. S. Savings Bonds) provide in many cases a secure investment, usually with small risk factor and generally quick liquidation. The safety factor is usually high, but it must be remarked that the word "bond" is not magic in itself. There are bonds of high, medium, and low grade, and this form of investment should be limited to the first two.
2. Preferred stocks represent ownership of a portion of a business venture and usually carry a specified rate of return; they are usually of a slightly lower degree of safety than bonds, but obtainable in high, medium, and low grades.
3. Common stocks, represent ownership of a portion of a business venture in the form of "shares";  assumption  of larger risks coupled with a higher rate of return; speculative element always present; various gradations in risk usually reflected in price. Opportunities for growth of capital often present, but may require some sacrifice of rate of return and the assumption of more than average risk. A hedge against inflation (see below) is provided by many defensive equities coupled with a fair degree of security and an expanding national economy, recent change in attitude toward  common   stocks has resulted in a reappraisal of their suitability (e.g., stocks of public utilities) for investment purposes. Easily obtained by the investor of modest means, as described in a later chapter but probably require more careful selection and supervision than any other single investment category. (Discussed in detail in Chapter 5.)
4. Mutual funds or investment trusts are considered by many to be an ideal method by which the investor may obtain the advantages of diversification in investments without the cares and problems of supervision and managership. Easily obtained by the small investor but rate of return somewhat lower than similar investments made directly. Some of the better funds enjoy a high reputation for success in the field.  (See Chapter 6.)

The question of the protection of investment by adequate diversification may be answered in a number of ways. First of all we will apply the principle to the over-all program.

It is quite evident that Mr. A, with $1000 in savings and $3000 additional which he has placed in common stocks, has not achieved proper diversification; for the stocks, in which he has three-fourths of his funds, are character­ized by strong changes in price and dividend return, since they are valued from day to day. This reappraisal is made in the light of general business conditions, the earnings of business en­terprises, technical developments, political im­plications, economic changes, and the like. Mr. A, therefore, runs a very substantial risk in having so large a percentage of his available funds in common stocks, since at certain times there may be a serious loss of principal and ac­companying loss of income.

Mr. B goes to quite an opposite extreme. He places all of his funds in cash and high-grade bonds, since he thus obtains strong price stabil­ity and a relatively fixed rate of return; bonds, being payable in a fixed number of dollars and carrying a prescribed interest rate, fluctuate in value far less than stocks. If he is the sort of person who wishes nearly complete freedom from investment cares, he is probably doing the right thing.

These two cases represent rather wide ex­tremes. They are presented in order that we may properly ask whether there is some neutral position between them and whether there is some distribution of investment funds which will accomplish diversification and, at the same time, not lean too much in one direction or the other. In other words, is there some "happy medium"? Fortunately, there is, although au­thorities differ as to the details whereby it may be accomplished. Some insist upon a rigid for­mula which would put half of all available funds in fixed obligations (cash, bonds, high-grade preferred stocks), with the remainder being placed in common stocks, the assumption being that (a) if business conditions become very good, some of the fixed-dollar obligations will be sold and the proceeds transferred into com­mons;   (b)  when times are not so prosperous and the consequent outlook for common stocks becomes uncertain, then the investor will im­mediately dispose of most, if not all, of his com­mons and place his funds almost entirely in fixed-dollar investments. This formula scheme is a good one and has shown excellent results in the past (it is practiced successfully by many individual investors and by investment trusts), but for our representative investor, whose funds may be modest, it has several drawbacks. First, the investor must determine when to make such switches from bonds into stocks and vice versa; second, with restricted funds he cannot afford to be going constantly into and out of the mar­ket, because commission charges will seriously reduce his net return; third, it requires con­siderable technical knowledge, time, and skill to do this with any degree of success; fourth, in ad­dition to the problem of when to buy or sell there is also the problem of what to buy or sell, since certain good-quality common stocks possess "defensive" characteristics (e.g., the public utilities) and perhaps should not be sold at all. It may seem that the investor is upon the horns of a dilemma, but there is a solution. In order best to answer the question of how to de­vise a sound program for the investor of modest means, we will first set up the following table so as to focus our attention upon the fundamen­tal investment characteristics of certain invest­ment media:

A careful examination of the table below shows:

1. that the safety factor and the assurance of income decrease as we read downward;
2. that the rate of return increases as we read downward, but its probability likewise de­creases;
3. that the degree of total risk is least at the top and is most at the bottom of the table.

Authorities differ, as we have remarked be­fore, as to the best distribution of investment funds, but they seem to be unanimous in the opinion that safety should be the watchword for the majority. They also state that the small in­vestor cannot afford to assume great risks, and that he should not have a large proportion of his funds in securities which carry a considerable risk factor. With this conservative approach in mind, we may say with considerable assurance that Mr. J. Q. Citizen would do well to place

1. At least half, and as much as three-quarters, of his funds in categories A and B;
2. Of the remaining half or quarter, the major portion should be placed in C, perhaps a small amount in D, and none whatever in E.

This is not to be considered a rigid commit­ment, because much depends upon the investor's personal background coupled with his invest­ment objectives. At the same time, the experi­ences of the past have shown that a conservative approach to investment is the best, the most sensible, and the most successful. An investor may say, "I'll put all my money in common stocks and make a fortune," but in so doing he is overlooking the basic principle of diversifica­tion—the spreading of investment funds over the various classes of investment in order to min­imize risks.

CHARACTERISTICS OF BONDS                 AND COMMON AND PREFERRED STOCKS
Class                                Type                                      Characteristics
A                                               high-grade, long-term          Highest safety of principal; continued
                                                  income, low
bonds                                            rate of return, strong price stability.
B                                               good grade bonds; Higher rate of return, with reasonable
                                                  safety; risk
high-grade preferred stocks          factor slightly greater than above.
G                                               high-grade commons          Fair degree of safety, with higher income than (defensive type) above, but subject to fluctuations in value and rate of return.
D                                               medium-grade commons    Higher degree of risk, coupled with variable rate of return; wide fluctuations in value; possible ap­preciation of capital.
E                                                speculative commons         Widest fluctuations; little or no return; highest degree  of speculation;   low  safety  of principal amount.

There are several other ways in which diversi­fication may be put into practice. One of these is the following: if more than one investment is to be made in a given category (e.g., stocks), it should be done with industry diversification in mind. For example, if the first purchase was made in the shares of one of the petroleum com­panies, then the next commitment should be in some other form of business (chemicals, food, manufacturing, etc.); by this means we protect our investments, because there are at times un­favorable developments which may affect an en­tire industry and at the same time may not affect any others. For instance, legislation with regard to certain segments of the natural-gas industry had an effect upon the securities of this industry; in a similar manner, the imposition of controls upon the sale of foodstuffs during World War II had a strong depressive effect upon the securities of many of the members of the "chain store" food group.

Another valuable form of diversification is that of geographical choice. Past experience has shown that investments made entirely in one geographical region are more subject to adverse effects than those which are more widely distrib­uted. For example, a hurricane which hit many of the New England states caused damage to many industries alike, since the hurricane plays no favorites in striking a certain area and will damage all kinds of business simultaneously. In the same manner, a prolonged drought may make its effects felt on all business in the area it effects.
Furthermore, all sections of the country do not show the same type and amount of eco­nomic growth; the output of goods and services in one section of the country may be increasing, while in another it may be static or even de­creasing. Population shifts in particular may cause some changes in the over-all prosperity of a given section of the nation; this is exemplified by the growth of California since the last war.

As we have remarked before, all investors are not alike. Different individuals may show many differences in certain personal attributes. Here are two examples.

Fred Firmrock is a careful, methodical, de­pendable sort of person. He would be classed as a "solid" citizen. Slow, soft-spoken, conserva­tive, he will never make a snap decision and in money matters he is also quite conservative. He wishes a fair rate of return upon his investment, but places complete protection of capital first; he is willing to sacrifice some of the former in order to obtain the latter. Since he insists upon the utmost in safety we may term him the de­fensive type of investor. High-grade bonds are for him, and with them he feels secure and con­tent.

Dan Dynamotor is a different sort of person. He is outspoken, makes up his mind quickly, and once he has determined a course of action, he will follow it out to a conclusion with all the resources at his command and with strong de­termination. Some feel that he is too sure of him­self, but all agree that there is never any ques­tion as to his opinion and his stand upon any issue. As a salesman he is eminently successful and has a keen interest in his work and an un­canny ability to judge people. In the field of in­vestment he wants a fair rate of return with reasonable protection of principal, because he realizes the growth possibilities of the nation and takes a long view of the future; he under­stands that there are temporary setbacks, but that the general trend of the national economy has been forward; he has a deep and sincere faith in the long-term advancement of the nation and this is reflected in his investment attitude. Consequently, he has bought somewhat more of common stocks than prudence would indicate, although they are well chosen in order to rep­resent some of the most progressive and dynamic industries of the day. He may be termed the aggressive investor who looks more to growth over the long term than for present returns. He does temper his outlook with a certain amount of caution, since he will not act in any situation without obtaining all the information he can; this attitude is to be commended and as a re­sult he has had but few disastrous disappoint­ments.

Neither of the above two examples is in any sense the true speculator whose main goal is a big, fast profit. He should not be held up as a pattern to copy, because he assumes rather sub­stantial risks which are far greater than the average investor has any right to take. Such speculation is only for those of considerable means, for whom any given loss will represent but a small percentage of their total investment assets.

Which kind of investor are you? Excluding the pure speculator, you may be defensive or aggressive, or even a blend of the two. At any rate, it pays to analyze yourself from the point of view of this distinction and see, as we have remarked before, that all investment is not al­ways such and may be diluted by a considerable measure of speculation. A frank, careful, and ob­jective analysis is always in order and will pay off in the long run.

For the sake of argument, let us suppose that the foregoing discussions have indicated that a satisfactory investment program may be formu­lated for our Mr. Citizen. This may at the mo­ment consist of a $1000 "rainy day fund" and an additional $1000 in U. S. Savings or other bonds. What of the next $1000? Should he place all of it in bonds? Should half be placed in an addi­tional bond and the other half be used to make the initial purchase of a common stock? If he follows the latter procedure he would then have (aside from the "rainy day" amount) three quarters of his funds in fixed-dollar securities and the other quarter in stocks. Is this the best possible commitment? To give a straightforward and unqualified answer will require the consid­eration of still another matter which may have a strong influence upon this decision.

INFLATION

Suppose that Joe Bugleblow had received some very good news in the spring of 1940. By registered letter he learned that he was one of the heirs of a certain Mathilda Abigail Bugle-blow, and that he was to present himself at the offices of the law firm of Smith, Cypher, and Zero with proof of his identity, in order that he might receive this bequest. Joe did so and found that each of several nephews had been be­queathed the sum of $500 in cash. In the fall of the year Joe again appeared for fund distri­bution of the estate and was presented with his proper share.

At first Joe thought of many ways of spending this money: a new camera, a new suit, a pair of field glasses, etc. He even jotted these items down on the envelope in which the currency was contained, and opposite each item he also set down its approximate cost. Again and again he fingered the five crisp $100 bills, each bearing the likeness of Benjamin Franklin; but the orig­inator of Poor Richard seemed both dignified and forbidding that morning, so that this im­pression, coupled with the recent outbreak of war and the prospect of being drafted, caused Joe to make his decision. He very quickly placed the envelope with its contents in his safe-deposit box at the local bank; for the moment he made no decision about the disposition of the legacy.

Years passed. Joe went overseas, was wounded, hospitalized, and finally, after spend­ing some time in various parts of the world, re­turned home and married his childhood sweet­heart. He had been promised a good job in California by a war buddy, so he went to the bank, took out all of his effects from the safe-deposit box and was surprised and pleased to find the envelope, which by this time he had completely forgotten. The five $100 bills still looked as fresh as the day he had received them, but when Joe glanced at his memo of prospec­tive purchases he received a severe shock, for the prices of these items had advanced in a star­tling fashion. We reproduce his notes, with the original (1940) prices at the left and the new (1952)   ones at the right:

$ 40..................... Suit of Clothes     $ 75.00
45........................ Camera       85.00
18........................ Field Glasses           37.50
16........................ Luggage      28.50
24........................ Dozen Shirts            40.00
135...................... Refrigerator           225.00

Need we go on? Need we show that a pound of butter jumped from 35¢ to 55¢ and that many food items bore price tags which represented advances of from 50 to 100 per cent; appliances, furniture, and many other forms of household goods had advanced in the same fashion, and
some of the more durable items had nearly tripled.
What had happened?

Joe, and millions o£ others like him, had re­ceived a lesson in the impact of inflation! He had found that the general rise in the price level during twelve years had been accompanied by a corresponding decline in the purchasing power of the dollar. The dollar bill still bore the like­ness of George Washington and still bore the legend one dollar, but it now bought only about 50 per cent of the goods it had purchased in 1940; hence the term "fifty-cent dollar."

The strange thing about inflation is that it has been a new experience to many, yet it is not new at all. There have been numerous past instances of it. For example, a strong inflationary trend began just after the close of the Civil War, prices advancing steadily to about the year 1895 and the dollar in that case losing more than half of its purchasing power. In a similar manner, there have been numerous cases of deflation, such as that which immediately followed the above ex­ample up to the year 1920, after which some inflationary tendencies again made themselves known. As an investor, everyone is interested in the effects of inflation upon his investment pro­gram, because he is interested in the preserva­tion of the principal amount as expressed in dol­lars which he originally invested, and in the income received, which is also expressed in dol­lars. In neither case is there any particular label put upon the dollars themselves. Only the na­ture of the times (the "price level") tells whether the dollars are inflated or not. Obvi­ously, the investor will be seriously concerned if his investments yield him a return in dollars which have lost their purchasing power by 50 per cent; not only that, he may have made a long-term investment (such as bonds) and when the invested capital is returned to him, he finds, much to his dismay, that it is in dollars that are not the same as those which he originally in­vested. Let us now show how this works out by a few examples, wherein we may find a clue to a means of minimizing the impact of inflation.

Suppose that in 1940 an investor bought a $1000 bond bearing 3 per cent interest. During the years that followed he would receive $30 each year as income from his investment for the period of the bond itself, say twenty years; at the expiration of that time, he would receive his original capital back again. There would be two things that would be difficult, if not impossible, to foresee: whether the dollars received as in­come would all be of the same value throughout, and whether the final return of principal would also be in money of the identical purchasing power which it had at the beginning. The same is true of all other fixed-dollar investments. Life-insurance dollars, when paid upon the death of the insured, may or may not buy as much as the dollars originally invested in the contract. Even money put away in a savings bank is not exempt from the ravages of inflation.

In the last decade elderly folk have been rudely awakened to the realization that their retirement income, of a fixed number of dollars, has proved insufficient and that they must make many personal sacrifices in order to get along; in some instances, where state or other govern­ment aid is provided, some effort has been made to soften the blow by providing modest increases in pension funds. Another case might be that of a widow whose husband left her "well pro­vided," only to find throughout the years that as a result of the gradual erosion in the purchas­ing power of the dollar the amount of her finan­cial protection had actually decreased with the passage of time.

From these examples one might conclude that the proper thing to do is to invest all one's money in such things as are revalued from time to time and to avoid strenuously all fixed-dollar obligations. At first glance this seems quite rea­sonable, and we may be tempted immediately to buy the three classes of investments which are valued from day to day: common stocks, com­modities, and real estate. Unfortunately, only the first of these is well within the reach and the investment scope of the average man. We often hear the statement that "common stocks should be bought as a hedge against inflation." From the viewpoint of cold statistics this may be shown to be true, and a very strong case has been made regarding the merits of common stocks. However, this does not tell the full story, for there are at least two important doubts which may be cast upon this rosy picture.

The first doubt, or shortcoming, concerns the behavior of the stock market. It is true that the market may show a sustained advance, but it does not follow that all stocks participate in this advance to the same degree! For example, sup­pose that an investor had picked five major chemical stocks at the beginning of the currently long-sustained high market, say in 1940. He would have done exceedingly well, having had a very comfortable income and considerable equity appreciation (gain in invested capital), because these stocks have been outstanding in their market performance. On the other hand, suppose he had invested in such things as meat packing, textiles, and farm equipment; his ap­preciation would have been far less and, in some instances, he might even have suffered losses! In other words, we have here a problem of care­ful and judicious selection, and it is only the best-qualified investor who may be right all the time—and even then, he is not always sure he will be 100 per cent right!

The second element of doubt concerns our blithe assumption that inflationary trends will continue forever. This is not necessarily so, since past experience has shown that inflation is eventually followed by a certain amount of deflation. When this takes place, the bondholder will again be on top of the pile, and the com­mon-stock investor will find his values have shrunk considerably. Should the latter be forced to sell in a period of falling prices, he may be required to accept severe losses. This means that common stocks may be a hedge against long-term inflation, but that the other side of the story is deflation, at which time the bondholder may be actually much better off; in addition, deflation actually restores the normal dollar, from which the bondholder will most assuredly have the most benefit.

The question of the value of money is a con­tinuous one and the haunting figure of inflation constantly appears in the background. Will in­flationary trends continue? Will they be arrested only temporarily? Will the next decade or two see the return of deflation, rather than an in­crease of inflation? Even a crystal ball will not answer these and similar questions.

Must we reckon with inflation in an invest­ment program? Most certainly we must! Just as fixed-dollar investments provide against defla­tion and just as investments in common stocks provide against inflation, so we must try to di­versify our funds so as to strike a reasonable medium. More and more the merits of common stocks are being seen in a new light; less and less are we making our comparisons with 1929; indeed, present-day analysts and investment counselors, bankers and brokers, have agreed that the placement of some funds in common stocks is both necessary and desirable.

THE FINAL PROGRAM

The foregoing discussions have made it evi­dent that over-all investment is not a subject to be approached lightly, or in a haphazard man­ner; diversification, being the underlying prin­ciple employed to minimize risk, must be ob­tained through (a) the media of investment; (b) the industries represented; (c) geographi­cal distribution. Throughout the entire plan lurks the danger of inflation or deflation, and these powerful forces must be taken into con­sideration. With all these things in mind, with the realization that ownership of common stocks constitutes a hedge against inflation, with the assumption that provision has been made for both a "rainy day" fund and adequate life in­surance, we may now arrive at a final program for investment. It has the advantage of relative simplicity:
TOTAL INVESTMENT FUNDS
divided into
Part I (60-40%)                                                Part II (40-60%)
In high-grade, fixed-dollar obligations: bonds, pre-      In common stocks, of which at least half must  ferred stocks  (A and B in previous table) table) be quality defensive type (C and D in  previous
Note 1: The percentage shown may vary with the individual himself, his objectives, the inflation­ary outlook, and other special factors; the extremes may be justified, but seldom exceeded.
Note 2: Diversification in common stocks may also be realized by participation in mutual funds and by purchase of bank and/or insurance-company stocks. See later chapters.

THE  FINANCIAL  PLAN

The above program does not differ materially from those commonly recommended by brokers, analysts, investment counselors, and other au­thorities; however, it allows for slightly more flexibility than many, and it may be tailored to the individual himself. The fact remains that there is no special formula, but that certain restrictions must be imposed, or else the entire idea of protection via diversification may be completely defeated.

Now consider the order in which the pur­chases of the above program should be made. For maximum protection it would be wise to ac­cumulate the investments in this manner: place the first amount (say $250 to $500) in those forms having the highest degree of safety, Part I; then the next succeeding amount in Part II; then the next in Part I, etc. At no time should the investor be caught in a situation wherein he has more than the indicated proportion of his funds in Part II; that would entail the pos­sibility of substantial losses upon quick liqui­dation. Any overbalance should always be weighted in the direction of Part I, merely as the exercise of additional caution.

The objection is often voiced that purchases in small amounts carry substantial commission fees. This is certainly not true of U. S. Savings Bonds, which are bought and redeemed without charge. In the case of common stocks of a total amount of $250, the commission is under 2i/£ per cent of the purchase price; and for higher amounts it decreases slowly. Compare this with the 5 per cent and even 10 per cent on real-estate sales and the higher amounts on various other forms of sale. It is true that the MIP (Monthly Investment Plan, devised by the New York Stock Exchange) does carry higher fees, but for some people a forced-savings method is worth the extra charge.

The statement is often made that the small investor has no business owning common stocks, perhaps because such ownership may represent too large a percentage of his total funds. Pro­vided this danger is avoided, the present writer takes strong issue. If the small investor will con­fine himself to the selection of better grade equities, if he safeguards himself by carrying out a well-balanced investment program, if he strenuously avoids all pure speculation, if he adopts an intelligent approach to the whole problem, then he may indeed do very well. Sta­tistics show that, from a study made on two normal trading days in 1954, 42 per cent of the shares bought and sold as "odd lots" (less than the normal 100 per share lot) were made by per­sons in the $5000 to $10,000 income group, and over 80 per cent of the business was classified as long-term investment. A recent estimate indi­cates that over 12,500,000 individuals own stock in publicly held corporations. The list of stocks bought under MIP are, for the most part, sound equities in leading corporations in various fields. It would seem quite evident that the large majority of Americans have confidence in the future of the nation and exercise good judgment in making their selections.

So far our discussion of common stocks as an investment has emphasized their purchase for income and as a hedge against inflation, but there is still another possible reason for buying them. This is called "capital gain" and refers to the fact that, over a period embracing several decades, the actual value of such shares may show a steady increase, regardless of market fluctuations. For example, a certain amount in­vested during the period 1920-30 in such stocks as du Pont, Monsanto Chemical, or General Motors would have shown, at present, a value of about thirty times the original investment. This is called "growth" and refers to the fact that corporations go through a life cycle con­sisting of certain stages, such as growth, matur­ity, and finally, decay. It must not be immedi­ately concluded that the stocks of all corpora­tions behave in the same manner in so doing; the important thing for our purposes is that some do grow, and it is these in particular which we wish to discover.

How may we identify a "growth" situation? There is no accepted formula for so doing, and the problem is quite difficult because the seem­ing growth of today may not be a continued growth tomorrow; however, there are certain signs which indicate that which we seek: a steadily increasing trend of earnings over a long period of time; continued or even increasing financial soundness; successful expansion of gross sales; continued ability to show consistent and even increasing profits; successful marketing of new or improved products; development of larger and more valuable sources of raw ma­terials; vigorous, farseeing, and aggressive man­agement (this last is perhaps the most difficult to appraise). It may be supposed that the ex­tremely youthful company will be what we are after; but this is not usually true, because such younger ventures are not always firmly es­tablished, are untried in the face of severe competition, are uncertain as to the continued acceptance of their products, and sometimes lack the "know-how" which is so necessary for con­tinued success. To the contrary, the well-estab­lished company, having gone through its initial "growing pains," may and often does present the best opportunity for further growth. It some­times requires the services of an investment analyst, counselor, broker, or investment service to find such a situation.

Since these situations are often recognized by many, the chances are that the demand for the shares of such corporations will be reflected in their price; consequently, the shares of many a true growth stock will often prove to be high priced, or even overpriced. Dividends may be very small, or even lacking entirely, since the management may wish to make use of surplus funds as far as possible and plow back all such earning potential. In addition, a considerable amount of expensive research is necessary to de­velop new products and new processes, so that expenditures of this type are sometimes an indi­cation of growth.

With regard to investment value we may state without equivocation that the so-called "growth" stock is often of greater interest to the younger and more aggressive type of investor, rather than the older and more conservative. The latter is more concerned with safety of both principal and income, while the former possesses the dynamic qualities and the longer life span during which his judgment may be vindicated. At the same time we must hasten to add that most growth stocks carry with them a somewhat higher degree of speculative risks, since the in­vestor is actually taking a chance as to whether the growth will eventually be realized.

Capital appreciation has become a worthy objective in the minds of some people in recent times because of the difference of tax treatment involved. Ordinary income is fully taxed, but the tax on long-term (over six months) capital gains is based upon only 50 per cent of the amount of the gain. Thus the investor may feel that the higher risk may be at least partially off­set by a decided tax advantage. For those of considerable means this is certainly true; for those of modest means it may not bulk so large, but it is still worth considering. Since all in­vestors are not alike, the purchase of "growth" type equities is a matter for individual decision.

Various studies have been made of the strong advantages in the ownership of common stocks, and one need not go far a field to find heated ar­guments in print regarding the relative merits of stocks versus bonds. Indeed, a very strong case may be made for either. While such studies are of interest, there is no need for the smaller in­vestor to be carried away by extravagant claims; some of the success indicated by some writers has much to do with the all-important element of proper timing, and this is obtained only by education, experience, and the building of a certain amount of "know-how"; this is best left to those who spend their entire time in this field and make a profession of it.

If we exclude pure speculation (something which cannot be recommended) there seems to be no good reason why the investor of modest means cannot achieve a reasonable degree of suc­cess by following the program previously out­lined. Many have done so. He will, it is true, have to undertake a certain period of training. Investment, as a specialized field, has its own language and a very extensive literature, and it will take some considerable amount of time to become familiar with it. Careful supervision must also be practiced in order to insure a rea­sonable amount of success, and it must be re­membered that this has to be continuous. There is no such thing as purchasing securities, whether they be stocks or bonds, and then com­pletely ignoring them. Conditions are always in a state of change, and these changes may be re­flected in the safety, value, and return to be real­ized from the investments themselves. More detailed treatment of the various types of invest­ment is to be found in the chapters that follow. The 60-40 system described above is a step in the right direction.

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