Those having money to invest may be classed in three groups: First, those persons who wish absolute safety of principal, permanency of investment, and regularity in the payment of dividends; second, those persons who are willing to take some risk, looking to a higher dividend rate, and other incidental benefits, such as business association with other stockholders, gain of knowledge of corporation affairs, etc., to indemnify them for lack of absolute security of the principal; third, those having a comparatively small amount for investment and willing to risk their money in concerns openly promoted for the purpose of enriching the backers if lucky, and with the expectancy of reaping large profits in a new and untried field- not properly called investments.
Investments are of two classes: First, the class in which the investors become the absolute owners of the securities, as in purchases of real estate, government bonds, etc.- these being purchase investments- and second, the class in which investors advance money upon the promises of borrowers to return the money with interest, and upon the securities which the borrowers pledge or bind in support of their promises, as in loans upon mortgages,- these being loan investments.
In determining the worth of an investment, the difference between the actual and permanent values of securities and the amounts of the corresponding investments is taken, this being termed the margin of safety. It is evident that this margin will vary in a direct ratio with the rate of income. A United States Government bond, for instance, yields less than 2 per cent to the investor, a state bond may pay 4 per cent, and a western farm mortgage 8 per cent.
Government bonds open to purchase have the advantage of safety, but the rate of interest is so low as to put them out of the investment class except where unconditional security is a prime requisite. The bonds of states which have borne a good financial reputation are comparatively safe. Municipal bonds are now very popular investments, yielding 3 1/2 per per cent to 5 per cent to the investor and at the present time are good and safe.
Contrary to the general opinion, real estate, improved or unimproved, is often a poor investment. Improved property, subject to taxes, depreciation, repairs, insurance, etc., often disappoints the owner. Real estate bought to lease for others to build upon is a good, but necessarily limited form of investment. Farm lands in the middle west have made fortunes for many in the past ten years, but taken year in and year out they may be said to be only a fair investment. Farm mortgages are among the best investments for safety, convenience and rate of income of any line offered the investor. Such investments should be passed upon by competent authority as to their legality, title to property covered, whether first or second mortgage, etc. Certain states have laws so framed that foreclosure is difficult and designed to protect the debtor. Loans in such states should be avoided except under exceptional conditions.
Speaking from wide experience in investments, David R. Forgan says:
"One of the worst forms of investment in real estate, in my opinion, is building and loan associations. They are gotten up in most attractive form to catch the month's savings of thrifty people with moderate incomes. I know there are some of these in the older parts of the country that are apparently succesful, but my experience of them in the west leads me to consider them as a whole almost the easiest concerns to get your money into and the hardest to get it out that I know. Their plan seems so simple that anyone can understand them; nevertheless one of my friends in Chicago, who is a thorough accountant, lost the savings of years in a building and loan association of which he himself was the annual auditor."
Bonds of corporations, as well as other securities should be purchased only after their safety has been assured by actual experience. The first issue, particularly of railroad bonds, is liable to contain some "water," for which the immediate investor will have to pay. Money should not be invested in bonds of any enterprise, as those operating public utilities, until the company is actually earning money to an amount not less than twice that required to pay the interest on its bonds. The reason for this is that the risk of financing an enterprise lies with the buyers of bonds. In case of success get but 5 per cent per annum, if a failure they are the only losers.
There are two main differences between bonds and stocks: (1) Bonds are a lien upon property of some kind, while stocks frequently represent nothing tangible other than earning capacity, good will and hope of the future; (2) bonds bear a promise to pay both principal and interest, enforceable at law, while a stock promises nothing, the stockholder becoming a part of the company. This is often an advantage, particularly to a young business man, giving him a chance as a stockholder to see the actual workings of a company, identify himself with it and be elegible to hold office. This is of particular value in a small town, as it often identifies a man in a business way, strengthens his credit and gains favors that would not otherwise be extended.
A large class of so-called investments are constantly being offered the public, such as mining stocks, oil stocks, plantation stocks, etc. Some of these are actual frauds, some partially fraudulent, and all are risky. They are often promoted by men having no means of their own and even if successful are so managed as to give those on the inside the profits. As a general rule rates of interest greater than 6 per cent or 7 per cent involve risks putting the investor in the speculator class.