Receiving every payment you were promised does not guarantee that your savings will keep you fed and housed. Prices can rise while the payment stays still. After tax, its buying power may shrink year after year.
Writing amid inflation and depressed markets in the early nineteen seventies, Philip Fisher measured safety by purchasing power. He argued that carefully selected shares could be less risky over decades than investments paying fixed interest. A business can increase what it earns. A fixed payment cannot. But the business has to withstand inflation itself, and its shares have to be bought at a suitable price.
A bond also has a price that can fall. If new bonds pay more interest, an older, lower-paying bond becomes less attractive to buyers. Selling it can mean accepting a loss. Falling interest rates may instead lift its price, although some contracts let the borrower repay early at a specified price, limiting the gain. Fisher contrasts that possible one-time appreciation with a business's ability to develop new sources of earnings.
When rising profits leave little to spare
Owning a business provides no automatic shelter. Inflation treats companies differently, and higher reported profits can hide a growing shortage of cash.
Consider the accounting Fisher describes. Depreciation spreads a machine's original cost over its useful life. If the replacement costs much more, that allowance falls short. Some apparent profit must now replace the old machine, merely keeping production going. Inventory also costs more to replenish, while customers owe more dollars for the same goods. The company has to finance the wait for them to pay.
Taxes can deepen the problem. Accounts based on old equipment and inventory costs may show taxable earnings even though the money is needed to maintain existing operations. Tax takes away part of that replacement money. A company can report success while becoming more dependent on borrowing.
Fisher therefore looks for growing earnings and margins wide enough to finance expansion and inflation's extra demands internally. Businesses needing little equipment, inventory or customer credit have less to finance. Those with substantial assets require closer examination. More productive replacement equipment or assets that remain useful for many years can help.
His cement example shows why an old plant could become especially valuable. Before World War Two, excess capacity kept prices and profits low. Postwar construction eventually required more cement than existing plants could supply. Inflation had made new plants expensive. Prices had to rise enough to justify building them, and the older, cheaper plants sold at those same higher prices. Their margins widened. Fisher reports that owners who had bought earlier gained more than the dollar lost in purchasing power.
The advantage depended on a shortage and plants that were still useful. Rapid obsolescence could have forced expensive rebuilding. Without demand for new capacity, prices might never have risen enough. And a company benefits only to the extent that its products share these favorable conditions.
Pricing freedom matters too. A low-cost producer can endure pressure longer than weaker rivals while the industry adjusts prices. The utilities Fisher examined faced a different problem. They waited for permission to raise rates as costs kept climbing. New plant still needed funding, so borrowing increased while the owners' financial cushion weakened. Interest became harder to cover, and lenders demanded more. The promise of an allowed return offered little protection if approval arrived too late.
Borrowing can bring a second injury. Fisher argues that inflation increases demand for funds and pushes interest rates upward. For companies needing new loans or refinancing, higher interest bills reduce profits. Higher rates can also reduce what investors will pay for each dollar of earnings. Both the earnings and the price attached to them can fall.
What the savings have to pay for
These conditions make Fisher's preference for selected businesses demanding. A familiar name, an impressive dividend or a long history cannot establish safety. Choosing the right operation and judging its price require expertise, either your own or that of capable help. Even good shares can decline sharply, and the owner's circumstances and temperament must allow for that possibility.
Fixed income can fit a different job well. An institution owing a specified number of dollars can hold assets that pay those dollars. Inflation changes their buying power, but the obligation remains fixed. Short-term instruments can also hold funds while an investor investigates a longer-term opportunity. Repeatedly renewing them forever leaves the purchasing-power problem unresolved.
Personal needs can take priority over either investment. Fisher gives a sound, reasonably priced home first claim on most people's funds because living in it meets a future housing need at current prices. That differs from running a rental property for income. He also wants a reserve for unexpected needs before money goes into shares.
Whether investment income must be spent or can be saved changes the choice as well. An owner paying today's bills may need dependable distributions; someone still saving may benefit from leaving earnings in a business that can use them well. Neither preference follows simply from being rich or having only a little invested. The comparison begins with what the money must provide, and asks whether the investment can keep providing it as costs change.
Three things to keep
Safety includes what your money can buy, after tax and inflation.
Inflation protection depends on a company's costs, pricing freedom, funding needs and purchase price.
Fixed payments still have a place when they match actual obligations.