The prospective investor not only must appraise his own personal factors, but he must carefully define his objectives before he can begin. This means that he must come face-to-face with his over-all needs as relate 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.
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.
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.
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 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.
The careless investor will not take into account all of his risk factors and desires before he allows himself to be lead by the nose into one account or another by his broker. However, no matter how old or young you might be, it is possible to make much better-informed decisions about your investments if you first make a list of your priorities and what you want from your investment. It will save many tears in the long run.