The Investing Approach Continued

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:

(a) 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.

(b) 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.

(c) 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.