Your future depends on the revenue that comes in the future. The money you have now is not enough to get you by. You’re dependent on future revenue for your survival. So, should you cut all expenses to the bone and stretch what remains, or invest the little that’s left to generate future revenue?

When things look bleak, investment is the answer.

Everyone pulls in their horns when times get tough, but you won’t enjoy the spoils of the top 10% if you manage like the masses. When your competitors are cutting marketing, advertising, conference attendance, networking, and sales, seize the opportunity. Call on their customers. Mail to their customers. Continue advertising. Volunteer for a leadership position in your community or your trade organization.

During tough times, there will also be opportunity for you to provide your products and services to organizations that are looking for ways to cut. Maybe they want to kill their in-house solution and outsource it instead. You should be there, showing them how. Finding solutions for them.

Management consultant, author, and speaker Alan Weiss explains it this way in The Million Dollar Consultant. Imagine a professional sports team completing a season of .500 ball and then announcing at a press conference: “In view of our uninspired past season, we’ve decided to cut back on the coaching staff, reduce practice time, eliminate recruiting efforts, and half the size of our conditioning area.”

This team would be out of business in short order.

Difficult times are an opportunity to take a stand – to hit a different chord than the rest and push harder for success. Win business and build your brand by speaking confidently and explaining in no uncertain terms how you can help your clients survive and thrive.

Time Value of Money.

Most people would rather receive a dollar today than in the future, and would pay less for a dollar to be received in the future than today. This is the concept of time value of money. A dollar received today can be invested to earn a profit. The simple fact that a dollar received today can be deposited into a bank account to earn income supports the concept.

Risk.

The level of uncertainty about whether expected returns will be realized is referred to as risk. Because virtually no investment is 100 percent certain to provide expected return, investors discount anticipated future cash flows by a rate greater than the standard for risk-free investment — U. S. Treasury obligations (the risk-free rate). When presented with an investment opportunity, one of the key tasks in assigning value is to estimate risk.

Risk-Free Rate.

If receipt of a future stream of cash flows were completely certain, the discount rate used to convert them into present dollars would be the risk-free rate. For the past 100+ years, the financial world has looked to U.S. government obligations as the benchmark for risk-free investments, and we presume it still does. As such, we can look at the rate of return or yield paid or earned on U. S. obligations as a pure representation of the time value of money for investors. In theory, to entice investors to contribute money to an investment that is risk-free, a rate of return at least equal to the rate paid on U. S. obligations would be required. A one-year U.S. Treasury bill today earns around 0.2 percent, a very low rate historically.

Discount Rate.

The rate at which future dollars are converted or discounted to present dollars is called the discount rate, also commonly referred to as the hurdle rate, cost of capital, opportunity cost of capital or required rate of return. The discount rate is made up of two components, the risk-free rate (to compensate for the time value of money) and the risk rate (to compensate for the uncertainty of the expected future cash flows). This can be represented by the equation Rf + R = D, where Rf is the risk-free rate, R the risk rate and D the discount rate.

Discounting.

The mechanism used to adjust the value of a dollar received in the future into value today is called discounting. If one were to determine that he or she would pay just 80 cents for a dollar that was certain to be received in one year, the implied discount rate is 25 percent. If the time value of money for this particular investor is consistent over time, then for every year a dollar’s receipt will be delayed, a discount of 25 percent will be applied.

The present value of a delayed payoff may be found by multiplying the payoff by a discount factor. If C1 denotes the expected payoff at time period 1 (one year from today), then:

Present Value (PV) = Discount Factor x C1

The discount factor is expressed as the reciprocal of 1 + rate of return:

Discount Factor = 1 / (1+r)

The rate of return r is the reward the investor demands for accepting delayed payment. If we use the numbers from the hypothetical example above, we find that $100,000 to be received in one year, discounted at 25 percent, is indeed $80,000.

PV = [1 / (1+.25)] * $100,000

= [1 / 1.25] * $100,000

= 0.80 * $100,000

= $80,000

To illustrate how this concept is applied, let’s assume we buy XYZ business and expect to receive $100,000 at the end of each year for five years. To calculate the present value, list the payment to be received in each year, then discount the dollars to the present value as follows:

The value of XYZ Company is $268,928 or the sum of the present values of each expected future cash payment. To avoid having to calculate each discount factor, refer to any present value table that can be found online (for free) or in the back of any finance textbook.

Return on Investment.

The return on investment is generally referred to as the cash or profit gained from equity dollars invested. This is also referred to as Return on Equity (ROE). The return can be expressed as a dollar amount, or converted to a percentage by dividing the return by the equity deployed. Typically, returns are calculated on an annual basis and referred to as annual rate of return.

Dollars Received / Dollars Originally Invested = Rate of Return

The return also can be calculated on total capitalization (debt and equity) as follows:

Dollars Received / (Equity Capital + Debt Capital Invested) = Return on Total Capitalization

Example: If $50 was received in year one as a return on $200 invested, the rate of return would be 25 percent.

Required Rate of Return.

When considering the discount rate or required return, it is helpful to study the historical returns of various investments. The table below lists the average annual total returns earned on a variety of investments. Each of the investments is publicly traded (due to lack of information available on private investments).

1. Source: SBBI Valuation Edition 2010 Yearbook. Returns are the average annual total (income and capital appreciation) arithmetic mean for 1926 to 2009 in the United States.
2. Micro-Cap Stocks is defined as the portfolio of stocks comprising the 9th and 10th deciles of the New York Stock Exchange. According to the Center for Research in Security Prices, University of Chicago, the average capitalization of micro-cap companies from 1926 to 2009 was $68 million.
3. Returns are return to total capitalization (debt and equity).

Each investment listed in the table above is publicly traded, thus marketable, i.e., it can be liquidated and turned into cash in about three days or less. The lowest historical rates of return were U.S. Treasury bills at 3.7 percent annually. The highest was micro-cap stocks at 18.2 percent. Of course, these were the investments with the lowest and highest risks, respectively. If we try to relate the returns on this table to small, privately held businesses, we can assume the required returns for such would be higher than the riskiest investment on the table — micro-cap stocks. The primary reasons are as follows:

The private company will be less marketable (very illiquid) than the average publicly traded micro-cap-size company and therefore riskier.

The average private company will be smaller than the average publicly traded micro-cap-size company and therefore has poorer access to equity and debt capital, lower levels of diversification, diminished opportunities to attract and retain talent, etc.

Business owners should have a working knowledge of the basic concepts of time value of money, return on investment and required rate of return.

The validity of diversification is so well accepted in finance that it is sometimes called the law of diversification. It’s a risk management technique. It espouses spreading around your investments among a diverse, unrelated group of investments rather than concentrating them in a single investment or a few, related investments. Diversification allows the investor to limit the impact that random and unforeseen events can have on a portfolio.

The inverse of diversification is concentration risk.

In the first days when a business is newly formed or purchased, there aren’t many ways for the typical investor/owner to avoid concentration risk. Consciously or subconsciously, he or she bears that risk in exchange for the chance to live the dream of freedom and independence. Some ways to limit concentration risk at the onset include obtaining additional equity investors, securing non-recourse debt financing, avoiding having your spouse sign as guarantor, not pledging your home or other personal assets as collateral, and buying or starting a business that requires only a portion of your cash or investable funds.

But as the business grows and prospers, the opportunities to diversify improve. The prudent business owner will do so, and the Internal Revenue Service Code provides meaningful incentives. Regular allocation of company profits to owner accounts (e.g., IRA, 401(k), Keogh, SEP) can yield significant gains over time in personal financial security and risk reduction. The goal is that the quality of your retirement would be acceptable even if disaster struck your company.

We all know that private business is inherently risky. Private investment is risky. Even home prices have declined recently. To gamble your entire financial well-being and retirement security on a single, private business is a risk no one should have to bear for an entire lifetime. It may be the nature of private business ownership, but it doesn’t have to be — at least not forever. Talk to your financial advisors about ways to diversify and lower your concentration risk. The Business Owner offers ideas that may be good places to start.

Limitations on who may convert traditional retirement accounts to the Roth no longer exist. This is great because you’re better off with your retirement funds in Roth accounts than any other form of retirement account. This is because:

• Withdrawals from a Roth are not subject to taxation. Withdrawals from other types of retirement accounts are taxed as ordinary income.
• There are no withdrawal requirements for monies held inside a Roth. So if you want to leave your money in your account beyond the age of 70½, you can — and it will continue to grow tax-free.
• If your heirs inherit your Roth, their withdrawals are also tax-free.

These are serious advantages. The proverbial fly in the ointment, of course, is that money and/or investments moved from traditional retirement accounts, i.e., traditional IRA, SEP IRA or Simple 401(k), to a Roth is subject to taxation. This is because, as you will recall, you funded the accounts with pretax dollars.1 Roth accounts work the opposite way: Contributions are made with after-tax dollars2 and withdrawals are tax-free. Withdrawals from other types of retirement accounts are taxed in the year of withdrawal as ordinary income.

So the benefits of having your money in a Roth are considerable, but moving funds from traditional accounts to the Roth will trigger a tax bill. Maybe you have tax losses that can be used to offset all or a portion of the conversion gain? Also, to help cushion the tax blow is a federal tax law that will allow you to spread your gain over the three years — 2010, 2011 and 2012 — as long as you make the conversion in 2010. If you wait until 2011 or thereafter, you’ll have to pay the tax on any conversion gain in the year of conversion.

Should everyone convert? No. In some cases, the tax hit may be too large. Talk to your financial advisor about your particular situation. Whether to convert your retirement account(s)3 to a Roth is not the same for everyone, but you’ll likely want to convert if some of the following apply to you:

• You have operating losses in your business. Unused losses from 2008 or 2009 or expected losses for 2010 or 2011. You can use them to offset Roth conversion gains and thereby reduce or eliminate the associated tax bill.
• You have cash outside your retirement account(s) you can use to pay the conversion tax (so you don’t have to pay a 10 percent early-withdrawal penalty).
• You won’t need to use the converted funds within the next five years or before you’re 59½ (Roth rules).
• You expect to have “decent” income during your retirement years (and therefore will be in one of the higher tax brackets).
• You think there’s a greater likelihood that overall income tax rates will be higher in the future, as opposed to lower.

Talk to your financial advisor today. The year is coming to a close and your ability to spread your conversion tax bill — if you have one — over two additional tax years will end on January 1, 2011.

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Footnotes:

1. If you have made after-tax contributions, they — and investment gains on these contributions — are not subject to taxation when moved to a Roth.
2. Most contributions are made with pretax dollars, but after-tax contributions can be made, too.
3. Note: Funds held in 401(k) and Solo 401(k) accounts (at least funds in these account types that did not originate from profit share contributions) cannot be moved to a Roth outside of a “distributable event” such as discontinuation of the plan, severance of employment, retirement or reaching age 59½.

For most businesses, profits are down. Revenue is down. No doubt, valuations based on profit or revenue are down. So if you’d like to increase your ownership percentage, would you like to buy when the price is high or low?

Low, of course.

So how about now?

Just food for thought. Of course, if your partners also hold this right and could buy you out at a predetermined formula price, don’t show them this article!

Q: Is your SBA lending more active now with the new programs initiated by the federal government?

A: Yes, it really made it attractive to people. The fee waiver and the increase in the guarantee level have created more demand for SBA loans.

Q: Will Bank of Oklahoma participate in the 100 percent guarantee program approved by Congress?

A: Yes we will, at least for existing customers with a viable business. We won’t be taking on new customers with this loan program right now because our take is it’s designed to help our existing customers first. We believe the program is set up to help our current customers retain jobs and to make loan payments for that six- to nine-month period.

Q: Are you seeing your loan demand increase?

A: Actually, I think we’re seeing an increase in awareness more than anything. The program and all of its benefits have been in the news more and we’re starting to get some questions answered. I think we have all the information as it pertains to the borrower, but there remain unanswered questions with respect to how the new programs will impact the lender.

Q: Are you still worried about loan quality even though the government guarantees up to 100 percent of the loan?

A: Actually, we don’t have all the information about the program yet. We know it’s a 100 percent guarantee, that the interest will be paid by the SBA, and the loan amount is $35,000. What we don’t know is how and when the loans will be subsidized. Will it be 1, 2, 3 percent interest that is paid to the lender? It’s certainly an attractive program, but we still care about loan quality. The SBA developed the program to bridge some gaps and to help eliminate credit risks that we might not be able to take on otherwise. But yes, the underlying credit qualities are still needed. We wouldn’t want to put loans on the books that cost the bank money, which can occur even in a 100 percent guarantee situation because it costs a lot of money for a bank to service a troubled account.

Pretty shocking, given the punishingly high cost. And since respondents reported using their credit cards as sources of funding, we can safely assume they carry balances. Add to this the turmoil in the credit card market today and we have at hand a real challenge for small companies.

In the NSBA’s recent study, conducted between April 27 and May 5, some 79 percent of the companies that responded reported worse terms on their cards (i.e., higher interest rates and fees) compared to the prior year. To be sure, credit card companies are paring down their loan limits, raising interest rates and fees, and reducing their risk. They’re doing so to try stemming their losses. See the accompanying tables that show the spike in delinquent accounts and bankruptcies.

Capital Is Critical

The issue here – funds needed to operate your business – is deadly serious. Run out of money and it’s game over. So what’s a business owner to do?

Of course, the best option is to build a business that generates cash and allows you to fund its operations through cash flow. Many business owners do achieve this, and you can, too.

This publication gives many tips for building such a business. And, of course, doing so is a long-term project. Furthermore, even businesses that generate strong operating cash flow may choose to use debt to fund rapid growth, enhance return on equity, or smooth the hit to cash caused by periodic capital expenditures.

So, what are your options?

Traditional Bank Financing

Have you tried to obtain traditional bank financing? Despite what you read in the press, banks are lending. More than that, they’re lending at all-time low rates of interest. So if you already have a relationship with a banker, give him/her a call to discuss paying off or paying down your credit card debt. If you don’t have a lender, get a referral from one of your business owner peers.

Keep in mind that new SBA loan programs are incredibly attractive. Your lender will be able to help you evaluate the programs and assess the opportunities.

In summary, business owners must get the funds they need. Credit cards are a substantial source of funds for small businesses and, at times, one of the only sources available. Every business owner should endeavor to move beyond credit card dependence as a primary source of funds. It’s just too expensive. Credit cards should be used for emergencies only.

A short-term funding source of last resort.

To qualify for a regular business loan, all you need is to build a relatively stable business that is profitable, has organized books and records, pays its income taxes and maintains modest levels of leverage.

You can get there. The Business Owner can help.

Yes, the U.S. government has taken bold steps to keep companies afloat during the downturn. Small Business Administration (SBA) guarantee levels have been increased to as high as 100 percent on some loans. In addition, it has waived all fees through the end of the year, raised the maximum business size threshold, and in some cases will even make your interest payment(s) for you!

Loan proceeds can be used for most sound business purposes, including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, new construction and leasehold improvement), and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.

Government Guarantee Helps Banks Say “Yes”
You still go to a bank to get the loan or refinancing, but government guarantees help banks say “yes” when they otherwise could not.

“We believe these changes are making a difference,” said Fred Munden, lead development specialist for the SBA’s Oklahoma City office. “Commercial lending is increasing and some businesses that were at risk of closure due to inability to refinance debt are now getting the funding they need. In some cases, it’s with a different bank, but the money spends just the same.”

“The program was a godsend for us,” said David LaGere, president and owner of Cherokee Architectural, a 12-person firm that manufactures ornamental staircases.

More Businesses Eligible
SBA loans are available to small businesses, and the definition of “small” has been temporarily expanded. From now until September 30, 2010, it’s any businesses with a tangible net worth of under $8.5 million and average after tax-income of less than $3 million during two fiscal years.

Borrowers cannot use the money to pay down SBA-backed loans made prior to Feb. 17, 2009.

100 Percent Guarantee, No-Interest Loans
A 100 percent guarantee program began June 15 and has a maximum loan amount of $35,000. Even more, all interest and fees will be paid by the SBA. The borrower has to repay only the principal. The best candidates are small businesses that have been profitable for one of the past three years but are now struggling and starting to miss loan payments.

Loan proceeds are disbursed over six months and repayment does not have to begin for 12 months after the last loan disbursement. Further, repayment can extend up to five years. Loans of this type will remain available until either the allocated funding runs out or Sept. 30, 2010, whichever comes first. Businesses are limited to one ARC loan apiece.

“This type of loan is designed to provide a shot in the arm for struggling companies,” said Munden of the SBA. “We want to help the qualifying companies make it through these tough times and come out the other end whole.”

Not for Start-Ups
Munden stressed that ARC loans are not for start-up businesses. “They are designed to help existing small businesses deal with making other loan payments,” he said. “Examples of qualifying loans include credit card obligations for your business, capital leases or notes payable to suppliers. They might also involve other loans made without an SBA guaranty.”

Application Requirements
Although SBA programs may make loans available to businesses that otherwise would not be able to qualify, there are underwriting standards that must be met. Lenders and the SBA will generally need the following from you when you apply:

Business Profile: A description of your business. Include what it does, the type of legal entity, its products, whom it sells to, the number of employees, a brief history and who owns the business.

Loan Request: A description of how much money is needed and what the funds will be used for.

Collateral: Description of collateral offered to secure the loan. Include equity in the business, borrowed funds, available cash, and assets such as accounts receivable, inventory, equipment and real estate.

Business Financial Statements: Complete financial statements for the past three full years plus year-to-date. This includes balance sheets and income statements.

Projections: Of revenue, expenses and cash flow for the next three years. Must show that the business can support repayment of the requested funds.

Business Tax Returns: Most recent three years.

Personal Financial Statements: For each person who owns 20 percent or more of the business, current personal balance sheets (i.e., a listing of all assets and liabilities and personal tax returns for the past three years).

For more information, including a complete list of SBA lenders, go to www.sba.gov.

Synonymous with “equity.” Calculated by subtracting the total value of all liabilities owed by the business from the total value of all assets owned by the business. A key question is how the assets and liabilities themselves are valued. One well-known method is “according to generally accepted accounting principles (GAAP).”

Tangible Net Worth

Net worth minus intangible assets.

Intangible Assets

Assets that have value but cannot be physically touched or easily valued, such as a brand, franchise, trademark or patent. Cash, receivables and payables are not difficult to value and therefore are considered tangible assets. Small and midsize private businesses may not have any intangible assets on their balance sheet, but if they do, it’s typically goodwill, which may have been derived from the purchase of another business, or capitalized expenses such as organization or research and development costs.

Book Net Worth

Simply the net worth of your business as shown on your financial statements. Also described as “unadjusted.”

Adjusted Net Worth

Derived by subtracting total liabilities from total assets after adjusting each to reflect its true value. For example, business assets almost always include accounts receivable. Let’s say that XYZ Company’s accounts receivable are shown on “the books” at $249,303, but the business owner knows that this amount includes $33,424 owed by PDQ Inc. that is past due and likely uncollectable. If the business owner were to prepare an adjusted balance sheet, he or she would amend the book value of receivables to reflect a more accurate estimate of value, including all assets and liabilities.

Webster’s Dictionary says:

Invest means to commit money to earn a financial return.

Gamble means to play a game for money or property.

Notice the difference? Investing is a serious matter. It’s business. It involves commitment, and the purpose is to earn financial return. When you succeed and earn a profit, you are not surprised. In fact, the big surprise comes when you suffer a loss.

Gambling, on the other hand, is a game. It’s not serious. It’s for pleasure and the outcome is uncertain. In fact, the outcome is mostly a matter of chance. When you win, you say, “Oh, wow, that was great!” When you lose you say, “Well, such is expected.”

Here are some additional distinctions.

Better Chance of Profit Than Loss.

Investments provide better odds for profit than loss, and this is determined by a reasoned, thorough and objective investigation of the facts. Of course, such an investigation on most games of chance leads one to conclude that the odds of loss are greater than the odds of profit. If you are considering a proposition and you do not have sound, fact-based reasons to conclude that a profit is likely, it’s not an investment opportunity. It’s gambling.

Quantity and Quality of Information.

The investor cannot, of course, determine whether an opportunity is worthy of his/her time and dollars unless he/she is provided with all of the information he/she deems necessary to adequately assess the opportunity. This involves issues of quantity (i.e., information of adequate supply on every factor that could impact the prospective future returns) and quality (i.e., the degree to which the information provided or obtained can be relied on to be true, accurate and credible). If information about an investment is not available in adequate quantity or quality, the investor cannot conclude that the investment is suitable.

Performance History.

Maybe the most vital piece of information is past performance history. For investments in businesses – whether publicly or privately held – this entails an analysis of the historical financial statements (i.e., income statements, balance sheets and statements of cash flows). The time horizon should be many years and, importantly, span a period of time that includes a recession (both in the industry in which the business operates and a broad economic downturn such as in 1973-1975, 1982, 2001 and 2008-2009). Only by analyzing performance during more challenging times can one really assess how the business might perform during such times in the future.

Speculation.

Investments do not involve speculation, which is defined as the “assumption of unusual business risk in hopes of obtaining commensurate gain.” Investments do not contain elements of hope. In contrast, investment decisions are based on a reasoned, thorough and objective assessment of the facts. If hope is at play in your decision to invest, what you’re doing is gambling.

Capital Preservation.

The ability to invest and earn income may be the greatest gift known to man this side of eternal salvation. To be able to earn income without the need to labor is what separates – dare I say elevates – the investment class from the working class. So, to the investor, nothing is more important than preservation of capital. Lose your capital (aka principal) and you lose your ability to invest. If you are considering an investment that could result in a total loss of your capital (i.e., the amount you invest), it’s not an investment.

Margin of Safety.

Investments that could result in total loss are not investments, they are gambles, and the only way to avoid the possibility of total loss is the concept of “margin of safety.” How is margin of safety assessed? By a reasoned and objective assessment of the facts. One must ask, “What is the worst-case scenario and, in that scenario, what is my return on investment?” For investments in businesses, whether the investment is in the form of debt or equity, one looks to:

• Historical and projected cash flow in good times and bad
• The certainty to which cash flow – in the worst-case scenario – will be able to meet all obligations, including, of course, operating costs and fixed obligations such as rent and debt service
• Tangible asset values relative to debt (aka debt-to-equity or leverage)

Return on Investment.

Investment is an activity engaged in to gain a return on investment, that is, a return of the capital deployed (i.e., the dollars invested, commonly referred to as the “principal”) PLUS a risk-adjusted return on investment. Of course, one will at times lose some principal on an investment, but this should be a worst-case scenario and, if five or ten investments are made, the overall return should be very positive (see “diversification” below).

Return of Investment.

An investment – even a risky investment – should at the very least provide a return OF your investment. That is, a return of your principal. Again, to the investor, capital preservation is paramount. One might be willing to accept some uncertainty as to the return ON investment, but a return OF investment (i.e., a return to you of the money you invested) should be virtually assured except in cases such as venture investment where diversification is used in a manner that allows losses on investments to be recouped by sizeable gains on others.

Diversification.

An absolutely fundamental and essential principle of sound investment strategy is that of diversification. Diversification, at its most basic, is a means for protecting against random risk. That is, risk of loss due to events that cannot be predicted or foreseen. Events such as these DO occur, and the only protection against them is the old adage “don’t put all your eggs in one basket.”

Time Horizon.

Games of chance tend to play out in very short time horizons. When you place your bet on a craps table or on a ball game, you learn your fate almost immediately. Investing, in contrast, involves longer time horizons, typically years. Returns may not be realized until many years after the investment is made, but the rate of return is calculated, or assessed, in average annual rates of return. The Internal Rate of Return (IRR) calculation is most common.

Time Value of Money.

Because investment returns are often distributed over many years, and because a dollar today is worth more than a dollar tomorrow, the investor will require much higher rates of return on investments that have a longer time horizon. Inherent in the concept of time value of money is:

• Need for inflation-adjusted return on investment
• Uncertainty rises considerably as returns are projected further into the future

So investors want to secure a return OF their investment (i.e., their principal, the investor’s highest priority) within as short a time as possible. Similarly, investors place a higher value on investments they expect will provide a return on investment over a shorter time horizon.

Optimism vs. Arithmetic.

The decision whether to enter into a particular investment should be based on arithmetic, not optimism, hope or blind faith. If your decision about whether to accept a proposition is based on whether others are doing it, run away. Any decision to invest should be founded on a fact-based investigation and whether, all things considered, you can reasonably expect both a return OF your investment and a return ON your investment that fully compensates you for the risk.

Risk and Required Rate of Return.

Any investment analysis includes an assessment of expected return in relation to degree of risk. Riskiness can be defined as variability in expected returns. Again, investments, by their nature, have variability as to return but should not also contain uncertainly as to whether a return will be earned at all. Also, as risk or unpredictability levels rise, the investor should demand higher returns to compensate. In short, very safe investments (i.e., investments in government securities or in debt instruments of financially healthy “blue chip” public corporations) should reliably return annual rates that exceed the rate of inflation by at least a few percentage points. On the other end of the risk spectrum, equity investments in new business ventures should provide annual returns in excess of (and, often, well in excess of) 25 percentage points above the projected rates of inflation.

Investment Performance in Difficult Economic Times.

Many poor investment decisions are made during times of broad economic prosperity. When the economy or industry has expanded for four or five years in a row, many businesses and/or investments show promising track records of performance. The wise investor takes care not to assume that good times will continue indefinitely. You must assess how the investment will perform during difficult times, most likely right after you place your bet.

Guilty Until Proven Innocent.

Investing is not about fairness. It’s not about compassion. It’s not about pleasing people. It’s about earning a cold-hearted return on investment. It’s about the dead-serious business of ending up with more cash than you started with. If a reasoned and objective assessment of the facts cannot be used and lead to the logical conclusion that a fair risk-adjusted return will be earned, then the proposition cannot be deemed an investment, at least not a suitable one.

Thomas Tusser wrote that “a fool and his money are soon parted,” and every investor should keep this in mind at all times. Every investor’s perennial ambition should be to prove he is no fool. Benjamin Graham and Warren Buffett, widely accepted as the greatest investors of the past 100 years, both assert that it is not hard to succeed at investing and earn healthy returns over the long run; one need only adhere to sound investment principles. The litmus test is the issue of hope vs. rational expectation based on sound assessment of facts. If you find yourself including elements of “hope” or “excitement” in your decision whether to put your money into a proposition, you’re not investing, you’re gambling.

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The following provided meaningful guidance for this article:

Cottle, Sidney; Murry, Rogers F; Block, Frank E. Graham and Dodd’s Security Analysis, Fifth Edition. McGraw-Hill. 1988

Graham, Benjaim. The Intelligent Investor, Fourth Revised Edition. Harper Business. 1973.

Hangstrom, Robert, G. Jr. The Warren Buffett Way. John Wiley & Sons, Inc. 1995.