Under the circumstances it is best to eliminate from consideration all hazards to investments caused by the caprices of unforeseen forces and conditions which human judgment and foresight are powerless to control. Their interference with the intelligent employment of capital is similar to their effect on the duration of human life. It is as possible for a parent to feel certain beforehand that his new-born offspring will reach the scriptural age of three score and ten as it is for an investor, no matter how careful he is in his selection, positively to assume the safety of the capital he has laid out in a given security.

However, we do know, in determining the length of human life, the average age reached when the simple rules of health are carefully followed and when no fatality, whether accident or disease, intervenes to cut it short.

So it is with investments. By observing ordinary precautions they can be safeguarded against every contingency except unknown eventualities.

Distribution Of Risks

Large investors even go so far as to protect themselves against unexpected surprises. They diversify their investments; that is, they distribute their capital among different securities.

The life insurance business is based on a principle somewhat similar. Instead of selecting their risks, life insurance actuaries have successfully worked out a standard mortality table which is wonderfully accurate in determining the average death rate. By means of this mortality table life insurance companies can tell almost to the exact figure, the number of people out of every thousand who will die each year.

Underlying their mortality table is one broad law, which is that each person, before being insured, must be physically free from all traces of disease which can terminate fatally. This is simply the law of averages. Although not recognized very many years, not over seventy-five years at the most, this law has more than justified itself as a reliable measure of safety, and the proof is the enormous assets which the life insurance companies have accumulated. Collectively, their assets mount up into the billions of dollars. They represent the funds that are the bulwarks of protection for outstanding policies representing between ten and fifteen times as much. Fire, marine, and other types of insurance are operated in a similar manner. All their premiums are based on different average tables.

The same principle is now applied, more or less, to investments; that is, our large banks and institutions, with millions in capital at their command, divide their investments among different classes of securities as an insurance against all risk. In this way, financial loss resulting from an unforeseen hazard is so distributed as to cause very little harm, and risk is reduced to a minimum.

Laws based on the theory of averages have been enacted by various states for the protection of savings bank depositors. These laws govern the character of investments in which savings banks are permitted to place their funds. Some states demand of a railroad, before its bonds are acceptable as an investment for savings bank deposits, that it shall have paid dividends on all its outstanding stock uninterruptedly for a certain term of years; others require that only first mortgages on real estate shall be considered desirable and safe investments, and then only up to a certain amount of the property's appraised value. Loans to depositors are also limited. In some states, loans are restricted to not more than 10 per cent of a bank's capital to any one customer of the bank. As a protection against inflation, other states have empowered commissions to supervise the issuance of new securities by corporations. Even cities, towns, and counties are now forced by statutes to keep their bonded obligations within a certain percentage of the assessed value of their taxable property. All these precautionary measures are adopted for the protection of investors and as a check against reckless banking. It must be remembered that bankers must invest their deposits and make loans to pay interest to depositors.

You will often read in the descriptive circular regarding a bond that it is a legal investment for banks in certain states. This means that the corporation issuing the bond has strictly complied with the laws of these states.

The fulfillment of the requirements of some of the states before a bond becomes a legal investment for their chartered banks is regarded by investors as the hallmark of a high-class security, just as the "sterling" mark on silverware is accepted as a sign of its purity.

Diversity Of Investments

The foregoing discussion suggests a practical application of the principle of diversity of investments to the needs of the individual investor. As a general rule, conservative investment demands the introduction of the element of diversity. This is true whether the fund is large or small. Investments should be diversified in order to secure safety of principal and income; to get the greatest income compatible with safety; to secure the greatest degree of marketability; and to insure the greatest chance of price appreciation. However good one particular security may be, it cannot satisfy all the legitimate needs of a safe investment.

Intelligent investment demands that it be split up not only into different kinds of securities of the same general type, but into securities of different types. Five thousand dollars invested in first mortgage bonds of five different railway systems may not introduce any real element of diversity into the investment. They are all issues of identically the same type and as investment propositions are likely to respond in the same general way to economic and business conditions. To secure diversity it is desirable to invest, for example, in such a variety of securities as first-class railroad bonds, seasoned public utility bonds, and high-grade industrial bonds. Then if the investor wishes to take a little risk, he may try some reliable preferred or common stock.

A person's own immediate and probable financial demands must be considered in making these investments. If he is likely to be in immediate need of cash, he should invest chiefly in securities that possess a quick market. If on the other hand no immediate needs are in sight, he may choose securities less marketable but bearing a higher rate of income. One investment factor must be weighed and balanced against another in determining the suitability of an investment for a particular person.

In diversifying an investment, it is important for some people to choose securities on which the interest is payable at different periods of the year. To the well-to-do man it does not make much difference whether his income comes to him in a lump sum or not; but to a great number of investors, it is preferable to scatter as nearly as possible on a monthly basis. This fact is easily accomplished by diversifying investments in such securities as pay their interest at different times of the year.