SECURITY OF INCOME

1. Amount Received: High rate of income and security of principal do not go hand in hand. They are frequently inversely related. The* periodical income received by the investor is generally larger when the security of principal is meager than when it is very firm. Investment income ordinarily represents two elements of compensation; one element is known as "compensation for risk," the other is called "pure interest" and constitutes the payment for the use of money or its equivalent. Naturally, the greater risk that an investor takes when making a loan, the more income he demands to cover this risk.

2. Stability of Interest Return

It is important in studying an investment to determine the permanence or stability, as well as the amount, of the income to be received. Most people loan money in order to get a periodical income from it. The best assurance of receiving it is the permanence of the earning power of the borrower. An investor who lends money to a railroad that fails to make a profit on its operations is generally unwilling to receive a part of the railroad back in lieu of cash income. The income is payable in cash or its equivalent, so that the railroads must earn a profit over current expenses to pay the interest. If the company does not earn enough money over a period of years to pay its current expenses and regular interest charges there is usually no assurance of stability of income to the investors that have furnished funds to a company. A concern in this position finds it impossible or exceedingly difficult to sell its securities in the market because the majority of investors demand regular periodical income and will make commitments only in companies that have met their interest obligations over a period of years.

3. Maintaining Stability

What are the means at hand for maintaining stability of income? Back of this question lies the important distinction between bonds and stocks as investments. In the case of bonds the essential query is, "Has the lender or holder of the bond some right or power to demand and enforce the payment of the income by the debtor corporations?" In the case of stocks there is usually no such power, and, as a rule, the stockholder is less sure of his income than the bondholder. A great many investors, however, neglect the fact that a stockholder is only a proprietor and cannot enforce the collection of his investments; whereas the bondholder usually has some power. Whether the bondholder can personally and without legal assistance exercise that power, is another matter.

4. Taxation

Stability of investment income is affected by the taxes imposed upon it. Whenever the holder of a security is taxed on the income received therefrom, he is deprived of a part of this income. Hence, when making a purchase of an investment security he is never sure of the income he is to receive because the tax rate can be changed from year to year. This is the reason why many investors prefer tax-exempt bonds, i.e., bonds the income from which is not taxed. Such bonds furnish a greater certainty of income. Tax exemption in these days of high income taxation is a very important factor in the selection of investments.