This department is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give advice as to specific investments.
by MERRYLE STANLEY RUKEYSER
WHEN Jim Blake’s1 wife presented him with a son, he determined that his boy should be assured a college education. He knew that it takes nearly $1200 a year to support a youth in college, but Jim, in his hard-headed way, was impressed with statistics indicating that the average lifetime earnings of the college man total more than three times those of the grade-school graduate.
In this mood the young father promptly developed a savings plan by means of which he would start instantly to earmark part of his earnings to provide for his boy’s higher education. Specifically, he contracted to get a call on $5000, an amount equal to his own present yearly income. In eighteen years, through compound interest, Jim’s programme for buying money on the installment plan would assure Jim, Jr., access to the cultural inheritance of the race.
Acting once more on the advice of his insurance broker, Jim made provision for the educational budget through an education-fund endowment plan policy, which guaranteed that the boy would receive for four years, beginning when he reached eighteen, an income of $100 every month from September to June, plus an additional payment of $316.82 on September 1 for tuition. In substance, the policy was an eighteen-year endowment policy on the father’s life.
It meant an adventure in will power and thrift for the young couple during the next eighteen years, for the premiums amounted to $280.45 annually. The net cost would be lessened by an annual profit-sharing dividend, varying with the earnings of the insurance company. In spite of the heavy expense, Jim and Alice were eager to spare Junior from being an only child, and two years later little Doris was born. Long before she could realize its value, she too received a contract assuring her a college education. Since Jim was now thirty-three, the premium on this was slightly higher — namely, $282.90.
Jim perceived that his family expenses were inevitably rising, for he not only had to make the initial outlay for the visible tokens of a rising standard of living, but also had to allow for maintenance expense. His insurance programme inevitably expanded to include protection of his property as well as of his personal earning power. His policies included the following: —
$3000 residence burglary policy—annual premium $33.41
$3000 fire insurance on furniture and household effects — annual premium $4.36
$12,000 fire insurance policy on house — premium $16.00
$5000-$10,000 public liability policy, in case anyone should sue on account of injuries sustained on premises — premium $6.25
Boiler insurance, covering $5000 property damage in case boiler in the house should explode — premium $11.66
$1200 automobile insurance, including, fire, theft, collision, and property damage —premium $73.20
$5000—$10,000 liability insurance, in case automobile should cause injuries to others — premium $52.00
Fortunately, at thirty-three, Jim’s salary was raised to $6000 to take care of his growing liabilities, and he was able to strike off balance sheets of his position, keeping his outlays rigorously under control.
On the asset side, he had a $12,000 home, against which he owed $6000 on a first mortgage. It was his ambition to retire the mortgage at the rate of $1000 a year, so that in six years he would own the place free and clear.
His ten original building and loan association shares, taken out at the age of twenty-two, had recently matured; he added the $1000 realized on them to his investment portfolio and then promptly subscribed to twenty additional building and loan shares. His personal investments, consisting entirely of common stocks, were distributed as follows: —
$500 in shares of two automobile companies
$350 in a radio and communications enterprise
$1000 in three chemical companies
$700 in two mail-order houses
$200 in a copper mining concern
$400 in two producers of packaged goods
$550 in a moving-picture company
$600 in a rubber-manufacturing company
$100 in an airplane-transport company
$750 in electrical-equipment enterprises
$350 in a meat-packing company
$500 in a tobacco company
The wide diversification was part of Jim’s conscious effort to develop an investment programme which would be suitable for large additional sums when and if they became available. While his means were still small, Jim determined that his stock portfolio should he right in principle, even if the digits were at first tiny.
The stock holdings totaled $6000 and yielded annual dividends of $240. Jim looked upon this dividend income as the equivalent of nearly a fortnight’s pay. He looked forward to the time when his investment income would bulk relatively larger than his earned income.
Out of his current total income of $6240 (plus the undrawn earnings on his building and loan shares and the cash surrender value of his insurance), Jim had to pay: —
$2000 endowment insurance policy — $46.80
$13,000 ordinary life policy — $316.94
Two educational-fund endowment policies — $563.35
Property insurance — $196.88
Twenty building and loan shares-$100
Interest on $6000 home mortgage at 5 per cent — $300
Amortization of mortgage—$1000
Living expenses, including car and taxes — $3500
That left only $216.03 to put in the bank or to add to investments each year. However, Jim recognized that in six years, after the house had been fully paid for, another $1300 would be freed for annual investment.
As he approached thirty-five, Jim was conscious of an additional financial need — namely, a cash reserve fund. He realized that as a family head, occupying an important business post but withal an employee working for someone else and hence subject to his whims, he faced a special risk: that of losing his place in the community through disagreement with his boss. Of course there was no expectation of this happening, but he wanted to be prepared for it.
Accordingly he decided to supplement his common stocks with securities better adapted to the exigencies of a cash-equivalent fund. For this purpose he concentrated on reasonably short-term United States Government bonds, on the theory that they would be subject to a minimum of price fluctuation, and could therefore be advantageously marketed whenever his family needs required.
Fortunately, annual salary increments were financing Jim’s broadening ambitions. When he was forty, his high-grade bonds were equal in amount to his common stocks. Now he saw the advantages of a balanced investment diet.
Even in his common-stock buying, his investment policy bad begun to shift. He stopped acquiring non-income-producing stocks, and concentrated exclusively on dividend payers This change in his point of view came partly from his determination to reinvest all dividends and interest received in order to increase his principal sum through the magic of compound interest.
Jim periodically challenged the right of individual stocks to remain in his portfolio.
He applied the following tests: —
1. Is the corporation a powerful factor in an essential industry, with a promising growth trend?
2. Is the human factor on the management side sound and dependable?
3 Is the company making ample write-offs for depreciation and obsolescence?
4. Is it making progress in research, and in steadily reducing the cost of production in terms of man-hours?
5. Are the accounts intelligible and candid?
When he was forty-five, Jim had the title of general manager of the store, and a salary of $12,000— making him, incidentally, the bestpaid hired man in Middletown. But Jim worried increasingly over the fact that his employer’s sons were beginning to look toward the business which their father had built up for them. Despite his enthusiasm for their courage and optimism, Jim was troubled at the prospect a few years hence of taking orders from them. At length he determined to cut loose, and venture on his own. He felt that he could afford to, for, as a result of reinvesting all his dividends and interest, his savings had accumulated to the sizable sum of $30,000. Jim converted two thirds of this amount into cash as working capital for his new business, including a down payment on his lease.
In the nature of things, Jim’s decision aroused much ill feeling among his former business associates. Jim felt, however, that the growth of the city warranted another department store and he believed he had a right to capitalize his twenty-three years of merchandising experience.
But he was soon to learn that operating a new business, from scratch, with no momentum, was quite different from piloting a successful going concern. Winthrop’s store, with its longestablished good will, continued making profits despite the loss of its gifted general manager. On the other hand, Jim’s adventure at the end of the first year revealed a $5000 deficit, before allowing any salary for himself. The next year he drew $6000 as salary, and cut the net deficit to $4000.
By the end of the third year, Jim had been able to draw $7500 in salary, while the business broke even. A year later he took the same drawings, and the business for the first time disclosed a net profit —$5000. It took this long for salary plus profit to equal the salary which Jim had received four years before when he resigned from Winthrop’s. Meantime, his financial risks had increased notably — and for four years he had lost the earning power on two thirds of his investments.
But Jim’s investment in himself was justified by long-term results. After the fifth year, the business showed increasing profits annually, and Jim soon found it feasible to draw out substantial sums for outside investment.
(To be concluded)
- This is the third of four installments presenting the life story of an investor as he moves around the circle from youth to old age.—EDITOR↩