Diversification as Practiced by Representative Individual Investors. In the fall of 1925, a questionnaire was sent to a large number of individual investors. The first question on the questionnaire is reproduced below:

Question I-What is the distribution of your investment list and what is your experience and opinion as to investment practice?

(a) In answer to this question, kindly fill in the following schedule in as complete a way as you can conveniently do so.

There were sixty-five replies to this question, distributed as

Of these about twenty were obtained by personal interview. A series of bar diagrams are pictured on Graph IV to illustrate how these individuals "diversify" their investments.

GRAPH IV

DIVERSIFICATION OF INVESTMENT AS PRACTICED BY SAMPLE GROUPS OF INDIVIDUALS OF A LARGE CITY

Diversification of investment of all investors

"Others" includes 11% face value of life insurance, 1% short term securities.

"Others" --6% life insurance,2% in trust and 1% short term securities. Diversification of investment of 14 well-to-do investors (not millionnaires)

"Others"--12% face value of life insurance and 3% short term securities

Diversification of investment of executives earning from $5,000 to $10,000

"Others"--19% face value of life insurance and 1% short term securities

"Others" --6% face value of life insurance and 1% short term securities (*) Not "professional" investors, but doctors, teachers, lawyers, etc.

A comparison of individual portfolios shows that the millionaires are the most consistent holders of common stock. No millionaire had less than 24% common stock on his list. One had as high as 85% so invested. This gives a range of 61%, but most of them were within a narrow range about the average

of 58%. It is quite surprising, from the point of view of tax problems, that the average millionaire holds as high as 58% in stocks, and 11% in preferred stocks, making a total of 69% in stocks. Of the twelve millionaires replying, eight said that these were largely held for purposes of controlling enterprises and they would reduce the amount so invested in favor of taxexempt securities provided they desired to give up their control of the enterprises in question.

Among the other groups a great variety of individual practices with respect to relative amount of common stock discloses itself, and the further down the list of types of investors, the more inconsistent they become with respect to the average person. The individuals among the professional group are the most inconsistent with their average. Thus, while the average type of investor of the professional group indicates a diversification among securities, it is discovered that this average becomes a diversified list only through the combination of a diversified group of individuals. One professional man had 92% of his investments in common stock, another 70%, another 68%, another 10%, several had 2%, and the rest had none in common stock. Rather than showing individual tendencies to diversification, the professional group (and the executive groups to some extent) show a fairly consistent tendency to concentrate as individuals upon some one type of security. The fact that the point of concentration varies from person to person gives the appearance of a concerted practice of diversification when an average is calculated.

Diversification by Corporate Fiduciaries and by Individual Investors Compared. There are similarities and also differences between the diversification of investment as practiced by corporate fiduciaries in the investment of trust funds, and as practiced by this selected group of individuals. It is a common feature of each to have large proportions in real estate and real estate securities, but there is a striking difference in respect to stocks and bonds. Whereas, on the average, corporate fiduciaries favored the contractual type of security (bonds), the individual investor, on the average, favored the equity type of investment (stocks) at that particular time (i. e., fall of 1925).

The average proportion of investment in stocks of all of the groups of individual portfolios studied is 48%, whereas the average proportion so invested by corporate fiduciaries is only 4.3% in the case of legal trust funds, and 5.8% in the case of discretionary trust funds. The average proportion invested in the contractual type of securities by individuals is only 11% (excluding real estate mortgages), whereas the average proportion so invested by corporate fiduciaries is over 34% in the case of legal trust funds and 31.5% in the case of discretionary trust funds.

The average diversification of investment between the equity type of security and the contractual type of security by a sample group of individuals presumably represents how a "prudent" investor will distribute his funds when the motive is his own profit and the funds are his own property. The theory of the law of trusts is that the trustee shall make his investment of funds held in trust, on behalf of the beneficiary, accord with that of a "prudent investor"; but the specific limitations of the law force the fiduciary to depart from the policy of a "prudent investor" to a degree here reflected or manifested by the actual difference in practice between investment policy of individuals and that of corporate fiduciaries. In fact the practice of corporate fiduciaries with respect to diversification between stocks and bonds is very nearly the opposite from that of individuals seeking their own interest. As to what should be the guiding principles for regulatory laws concerning investment of trust funds, the following generalization has been made:

"Obviously, the guiding principle should be safety-that is to say only 'safe' securities should be admitted-but safety is after all a relative term, and, as I have pointed out, it may, in the case of a trust, be obtained by broad powers and a wide field of investment, better than by limited powers and a restricted field.

"The provisions of such a law, therefore, ought not to be too narrow, but should be designed to admit such securities as would be representative of the safest forms of investment in such classes and in such diversity as would enable a trustee within the limitations of the legal list to administer his trust

in the same way that a prudent, wise and experienced individual would administer his own affairs during his lifetime." 1

Thus, approaching the problem of investment of trust funds by a study and comparison of actual individual investment experience, it is discovered that on the average individuals invest a greater proportion of their funds in stocks at certain times than in bonds, whereas at such times corporate fiduciaries continue to hold a relatively large proportion of bonds, due to legal restrictions, or other causes.

Principles of Diversification of Investment. A fundamental axiom in the theory of investment is properly to diversify investment in order to avoid unpredictable losses.2 Diversification of investment may be

1. Geographic-That is, investment in enterprises located in various parts of the country, or of the world.

2. Industrial-That is, investment in various types of industries; such as steel, lumber, textile, rubber, food industries, motor transportation, railroads and other public utility industries, etc.

3. Security-That is, investment in various types of securities such as stocks and bonds, and the various types of each.

The first type of diversification is virtually obtained along with the second type, due to the localization of industry. This particularly is true in a country such as the United States which has vast territorial expanse, and diversity of industry within its boundaries. The second and third types of diversification are thus the only ones applied to the list of investments in the foregoing study of investment experience by individuals and by corporate fiduciaries. The third type of diversification is prin

1 Babcock, J. N., "Enlarging the List of 'Legal' Investments for Trust Funds, without Sacrificing Safety," Trust Companies, Vol. 42 (Jan., 1926), pp. 49-52.

2 Wortham, Howard F., "Practical Suggestions for the Investment of Trust Funds," Trust Companies, Vol. 43 (Sept., 1926), pp. 285–9; Lagerquist, W. E., Investment Analysis, pp. 22-4; Kirshman, John E., Principles of Investment, pp. 814-31; Herschel, A. H., The Selection and Care of Sound Investments, pp. 279-82. The principle is conspicuous by its absence, however, from Sakolski, A. M., Principles of Bond Investment.